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Phase-Locking and Switching Volatility in Hedge Funds

Monica Billio (), Mila Getmansky and Loriana Pelizzon ()
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Mila Getmansky: msherman@som.umass.edu

No 2006_54, Working Papers from Department of Economics, University of Venice "Ca' Foscari"

Abstract: This article aims to investigate the phase-locking and switching volatility in the idiosyncratic risk factor of hedge funds using switching regime beta models. This approach allows the analysis of hedge fund tail event behavior and in particular the changes in hedge fund exposure to various risk factors potentially related to liquidity risk, conditional on different states of the market. We and that in a normal state of the market, the exposure to risk factors could be very low but as soon as the market risk factor captured by the S&P500 moves to a down-market state characterized by negative returns and high volatility, the exposure of hedge fund indexes to the S&P500 and especially to other risk factors changes signi?cantly presenting evidence of phase-locking. We further extend the regime switching model to allow for non-linearity in residuals and show that switching regime models are able to capture and forecast the evolution of the idiosyncratic risk factor in terms of changes from a low volatility regime to a distressed state that are not directly related to market risk factors.

Keywords: Hedge Funds; Risk Management; Regime-Switching Models, Liquidity (search for similar items in EconPapers)
JEL-codes: G12 G29 C51 (search for similar items in EconPapers)
Date: 2006
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