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Crisis and Hedge Fund Risk

Loriana Pelizzon (), Monica Billio and Mila Getmansky ()
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Mila Getmansky: Department of Finance and Operations Management Isenberg School of Management University of Massachusetts

No 2008_10, Working Papers from Department of Economics, University of Venice "Ca' Foscari"

Abstract: We study the effect of financial crises on hedge fund risk. Using a regime-switching beta model, we separate systematic and idiosyncratic components of hedge fund exposure. The systematic exposure to various risk factors is conditional on market volatility conditions. We find that in the high-volatility regime (when the market is rolling-down and is likely to be in a crisis state) most strategies are negatively and significantly exposed to the Large-Small and Credit Spread risk factors. This suggests that liquidity risk and credit risk are potentially common factors for different hedge fund strategies in the down-state of the market, when volatility is high and returns are very low. We further explore the possibility that all hedge fund strategies exhibit a high volatility regime of the idiosyncratic risk, which could be attributed to contagion among hedge fund strategies. In our sample this event happened only during the Long-Term Capital Management (LTCM) crisis of 1998. Other crises including the recent subprime mortgage crisis affected hedge funds only through systematic risk factors, and did not cause contagion among hedge funds.

Keywords: Hedge Fund; Risk Management; High frequency data (search for similar items in EconPapers)
JEL-codes: C51 G12 G29 (search for similar items in EconPapers)
Pages: 23
Date: 2008
New Economics Papers: this item is included in nep-fmk, nep-mst and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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