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Volatility of aggregate volatility and hedge funds returns

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  • Agarwal, Vikas
  • Arisoy, Y. Eser
  • Naik, Narayan Y.

Abstract

This paper investigates empirically whether uncertainty about volatility of the market portfolio can explain the performance of hedge funds both in the cross-section and over time. We measure uncertainty about volatility of the market portfolio via volatility of aggregate volatility (VOV) and construct an investable version of this measure by computing monthly returns on lookback straddles on the VIX index. We find that VOV exposure is a significant determinant of hedge fund returns at the overall index level, at different strategy levels, and at an individual fund level. After controlling for a large set of fund characteristics, we document a robust and significant negative risk premium for VOV exposure in the cross-section of hedge fund returns. We further show that strategies with less negative VOV betas outperform their counterparts during the financial crisis period when uncertainty was at its highest. On the contrary, strategies with more negative VOV betas generate superior returns when uncertainty in the market is less. Finally, we demonstrate that VOV exposure-return relationship of hedge funds is distinct from that of mutual funds and is consistent with the dynamic trading of hedge funds and risk-taking incentives arising from performance-based compensation of hedge funds.
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  • Agarwal, Vikas & Arisoy, Y. Eser & Naik, Narayan Y., 2015. "Volatility of aggregate volatility and hedge funds returns," CFR Working Papers 15-03, University of Cologne, Centre for Financial Research (CFR).
  • Handle: RePEc:zbw:cfrwps:1503
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    Cited by:

    1. Agarwal, Vikas & Arisoy, Y. Eser & Naik, Narayan Y., 2017. "Volatility of aggregate volatility and hedge fund returns," Journal of Financial Economics, Elsevier, vol. 125(3), pages 491-510.
    2. repec:eee:empfin:v:44:y:2017:i:c:p:91-107 is not listed on IDEAS
    3. Alper Gormus, N., 2016. "Do different time-horizons in volatility have any significance for the emerging markets?," Economics Letters, Elsevier, vol. 145(C), pages 29-32.
    4. Mathias S. Kruttli & Phillip J. Monin & Sumudu W. Watugala, 2017. "Investor Concentration, Flows, and Cash Holdings : Evidence from Hedge Funds," Finance and Economics Discussion Series 2017-121, Board of Governors of the Federal Reserve System (U.S.).
    5. Agarwal, Vikas & Green, Tracy Clifton & Ren, Honglin, 2017. "Alpha or beta in the eye of the beholder: What drives hedge fund flows?," CFR Working Papers 15-08, University of Cologne, Centre for Financial Research (CFR).
    6. repec:eee:jfinec:v:125:y:2017:i:3:p:610-636 is not listed on IDEAS

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    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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