Measuring Loss Potential of Hedge Fund Strategies

Marcos Mailoc López de Prado () and Achim Peijan
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Achim Peijan: UBS

Finance from EconWPA

Abstract: 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.

Keywords: Hedge Fund; Value-at-Risk; risk; performance; drawdown; under- the-water; normal returns; non-normal returns; time-dependence; ARMA; Monte Carlo; skewness; kurtosis; mixture of gaussian distributions; survival probability; styles; investment strategies (search for similar items in EconPapers)
JEL-codes: G0 G1 G2 G15 G24 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-mac and nep-rmg
Date: 2005-03-10
Note: Type of Document - pdf; pages: 25. Journal of Alternative Investments, Vol. 7, No. 1, pp. 7-31, Summer 2004
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0503010

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