IDEAS home Printed from https://ideas.repec.org/p/zbw/cfrwps/1507.html
   My bibliography  Save this paper

Tail risk in hedge funds: A unique view from portfolio holdings

Author

Listed:
  • Agarwal, Vikas
  • Ruenzi, Stefan
  • Weigert, Florian

Abstract

We develop a new tail risk measure for hedge funds to examine the impact of tail risk on fund performance and to identify the sources of tail risk. We find that tail risk affects the cross-sectional variation in fund returns, and investments in both, tailsensitive stocks as well as options, drive tail risk. Moreover, managerial incentives and discretion as well as exposure to funding liquidity shocks are important determinants of tail risk. We find evidence that is consistent with funds being able to time tail risk exposure prior to the recent financial crisis.

Suggested Citation

  • Agarwal, Vikas & Ruenzi, Stefan & Weigert, Florian, 2015. "Tail risk in hedge funds: A unique view from portfolio holdings," CFR Working Papers 15-07, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:1507
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/113657/1/833289756.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Aragon, George O. & Strahan, Philip E., 2012. "Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy," Journal of Financial Economics, Elsevier, vol. 103(3), pages 570-587.
    2. Getmansky, Mila & Lo, Andrew W. & Makarov, Igor, 2004. "An econometric model of serial correlation and illiquidity in hedge fund returns," Journal of Financial Economics, Elsevier, vol. 74(3), pages 529-609, December.
    3. Mark Mitchell & Todd Pulvino, 2001. "Characteristics of Risk and Return in Risk Arbitrage," Journal of Finance, American Finance Association, vol. 56(6), pages 2135-2175, December.
    4. Hodder, James E. & Jackwerth, Jens Carsten & Kolokolova, Olga, 2014. "Recovering Delisting Returns of Hedge Funds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 49(3), pages 797-815, June.
    5. Agarwal, Vikas & Arisoy, Y. Eser & Naik, Narayan Y., 2017. "Volatility of aggregate volatility and hedge fund returns," Journal of Financial Economics, Elsevier, vol. 125(3), pages 491-510.
    6. Jean-Sébastien Fontaine & René Garcia, 2012. "Bond Liquidity Premia," The Review of Financial Studies, Society for Financial Studies, vol. 25(4), pages 1207-1254.
    7. Graham, John R. & Harvey, Campbell R., 1996. "Market timing ability and volatility implied in investment newsletters' asset allocation recommendations," Journal of Financial Economics, Elsevier, vol. 42(3), pages 397-421, November.
    8. Agarwal, Vikas & Bakshi, Gurdip & Huij, Joop, 2009. "Do higher-moment equity risks explain hedge fund returns?," CFR Working Papers 10-07, University of Cologne, Centre for Financial Research (CFR).
    9. Bali, Turan G. & Brown, Stephen J. & Caglayan, Mustafa Onur, 2012. "Systematic risk and the cross section of hedge fund returns," Journal of Financial Economics, Elsevier, vol. 106(1), pages 114-131.
    10. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," The Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
    11. Stephen J. Brown & Greg N. Gregoriou & Razvan Pascalau, 2012. "Diversification in Funds of Hedge Funds: Is It Possible to Overdiversify?," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 2(1), pages 89-110.
    12. Bryan Kelly & Hao Jiang, 2014. "Editor's Choice Tail Risk and Asset Prices," The Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 2841-2871.
    13. Vikas Agarwal & Naveen D. Daniel & Narayan Y. Naik, 2009. "Role of Managerial Incentives and Discretion in Hedge Fund Performance," Journal of Finance, American Finance Association, vol. 64(5), pages 2221-2256, October.
    14. Hodder, James E. & Jackwerth, Jens Carsten, 2007. "Incentive Contracts and Hedge Fund Management," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(4), pages 811-826, December.
    15. William N. Goetzmann & Jonathan E. Ingersoll & Stephen A. Ross, 2003. "High‐Water Marks and Hedge Fund Management Contracts," Journal of Finance, American Finance Association, vol. 58(4), pages 1685-1718, August.
    16. Sadka, Ronnie, 2010. "Liquidity risk and the cross-section of hedge-fund returns," Journal of Financial Economics, Elsevier, vol. 98(1), pages 54-71, October.
    17. Andrew Ang & Joseph Chen & Yuhang Xing, 2006. "Downside Risk," The Review of Financial Studies, Society for Financial Studies, vol. 19(4), pages 1191-1239.
      • Andrew Ang & Joseph Chen & Yuhang Xing, 2005. "Downside risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    18. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," The Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
    19. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    20. Bali, Turan G. & Brown, Stephen J. & Caglayan, Mustafa O., 2014. "Macroeconomic risk and hedge fund returns," Journal of Financial Economics, Elsevier, vol. 114(1), pages 1-19.
    21. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    22. René M. Stulz, 2007. "Hedge Funds: Past, Present, and Future," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 175-194, Spring.
    23. Stephen J. Brown & William N. Goetzmann & James Park, 2001. "Careers and Survival: Competition and Risk in the Hedge Fund and CTA Industry," Journal of Finance, American Finance Association, vol. 56(5), pages 1869-1886, October.
    24. Bing Liang & Hyuna Park, 2007. "Risk Measures for Hedge Funds: a Cross‐sectional Approach," European Financial Management, European Financial Management Association, vol. 13(2), pages 333-370, March.
    25. Cao, Charles & Chen, Yong & Liang, Bing & Lo, Andrew W., 2013. "Can hedge funds time market liquidity?," Journal of Financial Economics, Elsevier, vol. 109(2), pages 493-516.
    26. Chen, Yong & Liang, Bing, 2007. "Do Market Timing Hedge Funds Time the Market?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(4), pages 827-856, December.
    27. Jonathan Ingersoll & Ivo Welch, 2007. "Portfolio Performance Manipulation and Manipulation-proof Performance Measures," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1503-1546, 2007 17.
    28. Vikas Agarwal & Wei Jiang & Yuehua Tang & Baozhong Yang, 2013. "Uncovering Hedge Fund Skill from the Portfolio Holdings They Hide," Journal of Finance, American Finance Association, vol. 68(2), pages 739-783, April.
    29. Teo, Melvyn, 2011. "The liquidity risk of liquid hedge funds," Journal of Financial Economics, Elsevier, vol. 100(1), pages 24-44, April.
    30. Adam L. Aiken & Christopher P. Clifford & Jesse Ellis, 2013. "Out of the Dark: Hedge Fund Reporting Biases and Commercial Databases," The Review of Financial Studies, Society for Financial Studies, vol. 26(1), pages 208-243.
    31. Nicole M. Boyson & Christof W. Stahel & René M. Stulz, 2010. "Hedge Fund Contagion and Liquidity Shocks," Journal of Finance, American Finance Association, vol. 65(5), pages 1789-1816, October.
    32. Edelman, Daniel & Fung, William & Hsieh, David A., 2013. "Exploring uncharted territories of the hedge fund Industry: Empirical characteristics of mega hedge fund firms," Journal of Financial Economics, Elsevier, vol. 109(3), pages 734-758.
    33. Agarwal, Vikas & Daniel, Naveen D. & Naik, Narayan Y., 2009. "Role of managerial incentives and discretion in hedge fund performance," CFR Working Papers 04-04, University of Cologne, Centre for Financial Research (CFR).
    34. François Longin & Bruno Solnik, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, April.
    35. repec:oup:rfinst:v:26:y::i:1:p:208-243 is not listed on IDEAS
    36. Bali, Turan G. & Gokcan, Suleyman & Liang, Bing, 2007. "Value at risk and the cross-section of hedge fund returns," Journal of Banking & Finance, Elsevier, vol. 31(4), pages 1135-1166, April.
    37. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," The Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 313-341.
    38. Aragon, George O. & Spencer Martin, J., 2012. "A unique view of hedge fund derivatives usage: Safeguard or speculation?," Journal of Financial Economics, Elsevier, vol. 105(2), pages 436-456.
    39. Isabelle Huault & V. Perret & S. Charreire-Petit, 2007. "Management," Post-Print halshs-00337676, HAL.
    40. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    41. Aragon, George O., 2007. "Share restrictions and asset pricing: Evidence from the hedge fund industry," Journal of Financial Economics, Elsevier, vol. 83(1), pages 33-58, January.
    42. John M. Griffin & Jin Xu, 2009. "How Smart Are the Smart Guys? A Unique View from Hedge Fund Stock Holdings," The Review of Financial Studies, Society for Financial Studies, vol. 22(7), pages 2331-2370, July.
    43. George O. Aragon & Vikram Nanda, 2012. "Tournament Behavior in Hedge Funds: High-water Marks, Fund Liquidation, and Managerial Stake," The Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 937-974.
    44. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    45. Carl Ackermann & Richard McEnally & David Ravenscraft, 1999. "The Performance of Hedge Funds: Risk, Return, and Incentives," Journal of Finance, American Finance Association, vol. 54(3), pages 833-874, June.
    46. Posthuma, Nolke & Sluis, Pieter Jelle van der, 2003. "A Reality Check on Hedge Funds Returns," Serie Research Memoranda 0017, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
    47. Kosowski, Robert & Naik, Narayan Y. & Teo, Melvyn, 2007. "Do hedge funds deliver alpha? A Bayesian and bootstrap analysis," Journal of Financial Economics, Elsevier, vol. 84(1), pages 229-264, April.
    48. Vikas Agarwal & Vyacheslav Fos & Wei Jiang, 2013. "Inferring Reporting-Related Biases in Hedge Fund Databases from Hedge Fund Equity Holdings," Management Science, INFORMS, vol. 59(6), pages 1271-1289, June.
    49. Jefferson Duarte & Francis A. Longstaff & Fan Yu, 2007. "Risk and Return in Fixed-Income Arbitrage: Nickels in Front of a Steamroller?," The Review of Financial Studies, Society for Financial Studies, vol. 20(3), pages 769-811.
    50. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    51. Stavros Panageas & Mark M. Westerfield, 2009. "High‐Water Marks: High Risk Appetites? Convex Compensation, Long Horizons, and Portfolio Choice," Journal of Finance, American Finance Association, vol. 64(1), pages 1-36, February.
    52. Chabi-Yo, Fousseni & Ruenzi, Stefan & Weigert, Florian, 2018. "Crash Sensitivity and the Cross Section of Expected Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 53(3), pages 1059-1100, June.
    53. Andrea Buraschi & Robert Kosowski & Fabio Trojani, 2014. "When There Is No Place to Hide: Correlation Risk and the Cross-Section of Hedge Fund Returns," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 581-616.
    54. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," The Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 275-302.
    55. William Fung & David A. Hsieh, 2004. "Hedge Fund Benchmarks: A Risk-Based Approach," Financial Analysts Journal, Taylor & Francis Journals, vol. 60(5), pages 65-80, September.
    56. Rodriguez, Juan Carlos, 2007. "Measuring financial contagion: A Copula approach," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 401-423, June.
    57. Liang, Bing & Park, Hyuna, 2010. "Predicting Hedge Fund Failure: A Comparison of Risk Measures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(1), pages 199-222, February.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Andrew W. Lo & Mila Getmansky & Peter A. Lee, 2015. "Hedge Funds: A Dynamic Industry in Transition," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 483-577, December.
    2. Agarwal, Vikas & Green, Tracy Clifton & Ren, Honglin, 2017. "Alpha or beta in the eye of the beholder: What drives hedge fund flows?," CFR Working Papers 15-08, University of Cologne, Centre for Financial Research (CFR), revised 2017.
    3. Vikas Agarwal & Stefan Ruenzi & Florian Weigert, 2018. "Unobserved Performance of Hedge Funds," Working Papers on Finance 1825, University of St. Gallen, School of Finance.
    4. Agarwal, Vikas & Green, T. Clifton & Ren, Honglin, 2018. "Alpha or beta in the eye of the beholder: What drives hedge fund flows?," Journal of Financial Economics, Elsevier, vol. 127(3), pages 417-434.
    5. Turan G. Bali & Florian Weigert, 2018. "Have Hedge Funds Solved the Idiosyncratic Volatility Puzzle?," Working Papers on Finance 1827, University of St. Gallen, School of Finance.
    6. Bali, Turan G. & Weigert, Florian, 2021. "Hedge funds and the positive idiosyncratic volatility effect," CFR Working Papers 21-01, University of Cologne, Centre for Financial Research (CFR).
    7. Hwang, Inchang & Xu, Simon & In, Francis & Kim, Tong Suk, 2017. "Systemic risk and cross-sectional hedge fund returns," Journal of Empirical Finance, Elsevier, vol. 42(C), pages 109-130.
    8. Benoît Dewaele, 2013. "Leverage and Alpha: The Case of Funds of Hedge Funds," Working Papers CEB 13-033, ULB -- Universite Libre de Bruxelles.
    9. Yang, Fan & Havranek, Tomas & Irsova, Zuzana & Novak, Jiri, 2022. "Hedge Fund Performance: A Quantitative Survey," EconStor Preprints 260612, ZBW - Leibniz Information Centre for Economics.
    10. Charles Cao & Grant Farnsworth & Hong Zhang, 2021. "The Economics of Hedge Fund Startups: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 76(3), pages 1427-1469, June.
    11. Dai, Na & Nahata, Rajarishi & Brauner, Aaron, 2022. "Does individualism matter for hedge funds? A cross-country examination," Journal of Corporate Finance, Elsevier, vol. 72(C).
    12. Agarwal, Vikas & Arisoy, Y. Eser & Naik, Narayan Y., 2017. "Volatility of aggregate volatility and hedge fund returns," Journal of Financial Economics, Elsevier, vol. 125(3), pages 491-510.
    13. Yang, Fan & Havranek, Tomas & Irsova, Zuzana & Novak, Jiri, 2024. "Where Have All the Alphas Gone? A Meta-Analysis of Hedge Fund Performance," EconStor Preprints 289497, ZBW - Leibniz Information Centre for Economics.
    14. Bali, Turan G. & Brown, Stephen J. & Caglayan, Mustafa O., 2014. "Macroeconomic risk and hedge fund returns," Journal of Financial Economics, Elsevier, vol. 114(1), pages 1-19.
    15. Mathias S. Kruttli & Phillip J. Monin & Sumudu W. Watugala, 2017. "Investor Concentration, Flows, and Cash Holdings: Evidence from Hedge Funds," Working Papers 17-07, Office of Financial Research, US Department of the Treasury.
    16. Canepa, Alessandra & de la O. González, María & Skinner, Frank S., 2020. "Hedge fund strategies: A non-parametric analysis," International Review of Financial Analysis, Elsevier, vol. 67(C).
    17. Chen, Honghui & Kumar, Alok & Lu, Yan & Singh, Ajai, 2022. "Do Hedge Fund Managers Understand Politics? Political Sensitivity and Investment Skill," Journal of Banking & Finance, Elsevier, vol. 135(C).
    18. Bali, Turan G. & Brown, Stephen J. & Caglayan, Mustafa Onur, 2012. "Systematic risk and the cross section of hedge fund returns," Journal of Financial Economics, Elsevier, vol. 106(1), pages 114-131.
    19. Yong Chen & Bing Han & Jing Pan, 2021. "Sentiment Trading and Hedge Fund Returns," Journal of Finance, American Finance Association, vol. 76(4), pages 2001-2033, August.
    20. Bali, Turan G. & Brown, Stephen J. & Caglayan, Mustafa O., 2019. "Upside potential of hedge funds as a predictor of future performance," Journal of Banking & Finance, Elsevier, vol. 98(C), pages 212-229.

    More about this item

    Keywords

    Hedge Funds; Tail Risk; Portfolio Holdings; Funding Liquidity Risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:cfrwps:1507. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: https://edirc.repec.org/data/cfkoede.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.