Hedge fund leverage with stochastic market conditions

Li Zhao, Wenli Huang, Chen Yang and Shenghong Li

International Review of Economics & Finance, 2018, vol. 57, issue C, 258-273

Abstract: Hedge funds face stochastic market conditions. We develop a dynamic framework to analyze hedge fund optimal leverage choice, in which the extra return and volatility of the alpha-generating strategy shift between good and bad states at random times. We find that the optimal leverage, the manager's risk attitude and her compensation in each state reflect the possibility for state shifts, in contrast to the results of the one-state model. The manager always intends to increase leverage when the probability of a coming crisis is higher; however, the leverage is significantly reduced when the crisis arrives.

Keywords: Hedge fund; Leverage; High-water mark; Financial crisis; State shift (search for similar items in EconPapers)
JEL-codes: G11 G23 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:57:y:2018:i:c:p:258-273

DOI: 10.1016/j.iref.2018.01.012

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