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Robust leverage choice of hedge funds with rare disasters

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  • Yan, Jingzhou
  • Mu, Congming
  • Yan, Qianhui
  • Luo, Deqing

Abstract

We study the effects of hedge fund manager’s ambiguity aversion for jump and diffusion risks on the leverage policy under a high-water mark contract. We find that the jump risk has an inverted U-shaped effect on the leverage choice, which can be explained by the variance effect and skewness effect. Our result also indicates that diffusion ambiguity aversion has a larger negative impact on leverage than jump ambiguity aversion. Manager’s ambiguity aversion in jump risk amplifies the skewness effect when the price jump is positive. Our findings provide some insights into the risk taking strategy of hedge fund under ambiguity.

Suggested Citation

  • Yan, Jingzhou & Mu, Congming & Yan, Qianhui & Luo, Deqing, 2023. "Robust leverage choice of hedge funds with rare disasters," Finance Research Letters, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:finlet:v:54:y:2023:i:c:s1544612323000636
    DOI: 10.1016/j.frl.2023.103689
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    References listed on IDEAS

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    More about this item

    Keywords

    High-water mark; Hedge fund; Leverage; Ambiguity aversion; Rare disasters;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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