Tracking market and non-traditional sources of risks in procyclical and countercyclical hedge fund strategies under extreme scenarios: a nonlinear VAR approach

François-Éric Racicot () and Raymond Théoret ()
Additional contact information
Raymond Théoret: Université du Québec (Montréal)

Financial Innovation, 2022, vol. 8, issue 1, 1-56

Abstract: Abstract The subprime crisis was quite damaging for hedge funds. Using the local projection method (Jordà 2004, 2005, 2009), we forecast the dynamic responses of the betas of hedge fund strategies to macroeconomic and financial shocks—especially volatility and illiquidity shocks—over the subprime crisis in order to investigate their market timing activities. In a robustness check, using TVAR (Balke 2000), we simulate the reaction of hedge fund strategies’ betas in extreme scenarios allowing moderate and strong adverse shocks. Our results show that the behavior of hedge fund strategies regarding the monitoring of systematic risk is highly nonlinear in extreme scenarios—especially during the subprime crisis. We find that countercyclical strategies have an investment technology which differs from procyclical ones. During crises, the former seek to capture non-traditional risk premia by deliberately increasing their systematic risk while the later focus more on minimizing risk. Our results suggest that the hedge fund strategies’ betas respond more to illiquidity uncertainty than to illiquidity risk during crises. We find that illiquidity and VIX shocks are the major drivers of systemic risk in the hedge fund industry.

Keywords: Hedge fund; Procyclicality; Illiquidity risk shock; Illiquidity uncertainty shock; Local projection model; TVAR; Optimal forecast; Measurement errors (search for similar items in EconPapers)
JEL-codes: C13 C58 G11 G23 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://link.springer.com/10.1186/s40854-021-00316-3 Abstract (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:fininn:v:8:y:2022:i:1:d:10.1186_s40854-021-00316-3

Ordering information: This journal article can be ordered from
http://www.springer. ... nomics/journal/40589

DOI: 10.1186/s40854-021-00316-3

Access Statistics for this article

Financial Innovation is currently edited by J. Leon Zhao and Zongyi

More articles in Financial Innovation from Springer, Southwestern University of Finance and Economics
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().