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Measuring Loss Potential of Hedge Fund Strategies

  • Marcos Mailoc López de Prado

    (UBS)

  • Achim Peijan

    (UBS)

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://econwpa.repec.org/eps/fin/papers/0503/0503010.pdf
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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
Contact details of provider: Web page: http://econwpa.repec.org

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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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