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Leverage and valuation of hedge funds under model uncertainty

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  • Yuxiang Bian
  • Xiong Xiong
  • Jinqiang Yang

Abstract

We extend the model of dynamic leverage and valuation of hedge funds [Lan, Y., N. Wang, and J. Yang. 2013. The Economics of Hedge Funds.” Journal of Financial Economics 110: 300–323.] by incorporating model uncertainty. Our theoretical model predicts that concerns about model uncertainty induce risk-neutral managers to behave more endogenously risk-averse and to choose a more conservative leverage strategy. Moreover, it shows that model uncertainty may reduce the valuations of hedge funds, including incentive fees, and total fees for the manager as well as the investors' payoff, while model uncertainty has ambiguous effects on the valuations of managers' management fees. Finally, we find that model uncertainty significantly increases the break-even alpha at the founding of a hedge fund.

Suggested Citation

  • Yuxiang Bian & Xiong Xiong & Jinqiang Yang, 2020. "Leverage and valuation of hedge funds under model uncertainty," The European Journal of Finance, Taylor & Francis Journals, vol. 26(17), pages 1798-1816, November.
    • Handle: RePEc:taf:eurjfi:v:26:y:2020:i:17:p:1798-1816
    DOI: 10.1080/1351847X.2020.1778054
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    Cited by:

    1. Bian, Yuxiang & Xiong, Xiong & Yang, Jinqiang, 2022. "Investor protection, hedge fund leverage and valuation," The North American Journal of Economics and Finance, Elsevier, vol. 62(C).
    2. Yan, Jingzhou & Mu, Congming & Yan, Qianhui & Luo, Deqing, 2023. "Robust leverage choice of hedge funds with rare disasters," Finance Research Letters, Elsevier, vol. 54(C).

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