Tail risk exposures of hedge funds: Evidence from unique Brazilian data

This paper examines tail risk in the Brazilian hedge fund industry. We rely on a unique data set of daily returns for every hedge fund in Brazil, dead or alive. By employing the universe of hedge funds, we ensure the absence of selection, survivorship, and instant history biases. We estimate tail risk measures based on the cross-section of both equity and hedge-fund returns. In particular, we rely on the expected shortfall of the cross-section distribution both under the physical and risk-neutral measures. We find that tail risk estimates are very different not only across asset classes (equity vs hedge fund), but also across probability measures (physical vs risk neutral). We also show that, although hedge funds in Brazil seem to exhibit more contemporaneous exposure to equity tail risk, which also partially explains the cross-section of their expected returns, hedge fund tail risk entails higher predictive ability to performance over time.