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Risk Procyclicality and Dynamic Hedge Fund Strategies


  • Francois-Éric Racicot

    () (Département des sciences administratives, Université du Québec (Outaouais), LRSP et Chaire d'information financière et organisationnelle)

  • Raymond Théoret

    () (Département de finance, Université du Québec (Montréal), Université du Québec (Outaouais), et Chaire d'information financière et organisationnelle)


It is well-known that traditional financial institutions like banks follow procyclical risk strategies (Rajan 2005, 2009, Shin 2009, Jacques 2010) in the sense that they increase their leverage in economic expansions and reduce it in recessions, which leads to a procyclical behaviour for their betas and other risk and financial performance measures. But it is less known that the spectrum of the returns of many hedge fund strategies displays a high volatility at business cycle frequencies. In this paper, we study this unknown stylized fact resorting to two procedures: conditional modelling and Kalman filtering of Funds alphas and betas. We find that hedge fund betas are usually procyclical. Regarding the alpha, it is often high at the beginning of a market upside cycle but as the demand pressure stems from investors, it eventually fades away, which suggests that the alpha puzzle documented in the financial literature is questionable when cast in a dynamic setting.

Suggested Citation

  • Francois-Éric Racicot & Raymond Théoret, 2011. "Risk Procyclicality and Dynamic Hedge Fund Strategies," RePAd Working Paper Series UQO-DSA-wp062011, Département des sciences administratives, UQO.
  • Handle: RePEc:pqs:wpaper:062011

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    References listed on IDEAS

    1. Shang-Wu Yu, 1997. "Terms Structure of Interest Rates and Implicit Options: The Case of Japanese Bond Futures," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(5), pages 593-614.
    2. A. Bellier-Delienne, 2005. "Synthèse sur les Options de Livraison dans les Contrats à Terme," THEMA Working Papers 2005-09, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    3. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
    4. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305 World Scientific Publishing Co. Pte. Ltd..
    5. Alan Brace & Dariusz G¸atarek & Marek Musiela, 1997. "The Market Model of Interest Rate Dynamics," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 127-155.
    6. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    7. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
    8. Hull, John & White, Alan, 1993. "One-Factor Interest-Rate Models and the Valuation of Interest-Rate Derivative Securities," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(02), pages 235-254, June.
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    More about this item


    risk measures; Aggregate risk; Financial stability; Conditional models; Kalman Filter; Spectral analysis.;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C19 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Other
    • C49 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Other
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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