Estimating Operational Risk for Hedge Funds: The ω-Score
Stephen J. Brown
New York University - Stern School of Business
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
University of Massachusetts Amherst - Department of Finance & Operations Management; China Academy of Financial Research (CAFR)
University of California at Irvine
Yale ICF Working Paper No. 08-08
Using a complete set of the SEC filing information on hedge funds (Form ADV) and the TASS data, we develop a quantitative model called the ω-Score to measure hedge fund operational risk. The ω-Score is related to conflict of interest issues, concentrated ownership, and reduced leverage in the ADV data. With a statistical methodology, we further relate the ω-Score to readily available information such as fund performance, volatility, size, age, and fee structures. Finally, we demonstrate that while operational risk is more significant than financial risk in explaining fund failure, there is a significant and positive interaction between operational risk and financial risk. This is consistent with rogue trading anecdotes that suggest that fund failure associated with excessive risk taking occurs when operational controls and oversight are weak.
Number of Pages in PDF File: 23
Keywords: mutual funds, hedge funds, investments, the Omega Score
Date posted: January 25, 2008 ; Last revised: September 11, 2009
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