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Measuring Loss Potential of Hedge Fund Strategies

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Author Info

  • Marcos Mailoc López de Prado

    (UBS)

  • Achim Peijan

    (UBS)

Abstract

We measure the loss potential of Hedge Funds by combining three market risk measures: VaR, Draw-Down and Time Under-The-Water. Calculations are carried out considering three different frameworks regarding Hedge Fund returns: i) Normality and time-independence, ii) Non-normality and time- independence and iii) Non-normality and time-dependence. In the case of Hedge Funds, our results clearly state that market risk may be substantially underestimated by those models which assume Normality or, even considering Non-Normality, neglect to model time- dependence. Moreover, VaR is an incomplete measure of market risk whenever the Normality assumption does not hold. In this case, VaR results must be compared with Draw-Down and Time Under-The-Water measures in order to accurately assess about Hedge Funds loss potential.

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File URL: http://128.118.178.162/eps/fin/papers/0503/0503010.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0503010.

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Length: 25 pages
Date of creation: 10 Mar 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0503010

Note: Type of Document - pdf; pages: 25. Journal of Alternative Investments, Vol. 7, No. 1, pp. 7-31, Summer 2004
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Web page: http://128.118.178.162

Related research

Keywords: Hedge Fund; Value-at-Risk; risk; performance; drawdown; under- the-water; normal returns; non-normal returns; time-dependence; ARMA; Monte Carlo; skewness; kurtosis; mixture of gaussian distributions; survival probability; styles; investment strategies;

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  1. Gaurav Amin & Harry. M Kat, 2002. "Generalization of the Sharpe Ratio and the Arbitrage-Free Pricing of Higher Moments," ICMA Centre Discussion Papers in Finance icma-dp2002-15, Henley Business School, Reading University.
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Cited by:
  1. Sevinc Cukurova & Jose M. Marin, 2011. "On the economics of hedge fund drawdown status: Performance, insurance selling and darwinian selection," Working Papers 2011-04, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales.

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