Derivatives Use and Risk Taking: Evidence from the Hedge Fund Industry
Texas A&M University - Department of Finance
January 31, 2010
Journal of Financial and Quantitative Analysis (JFQA), Forthcoming
EFA 2008 Athens Meetings Paper
This paper examines the use of derivatives and its relation with risk-taking in the hedge fund industry. From a large sample of hedge funds, 71% of the funds trade derivatives. After controlling for fund strategies and characteristics, derivatives users on average exhibit lower fund risks, such as market risk, downside risk, and event risk; such risk reduction is especially pronounced for directional-style funds. Further, derivatives users engage less in risk shifting and are less likely to liquidate in a poor market state. However, the flow-performance relation suggests that investors do not differentiate derivatives users when making investing decisions.
Number of Pages in PDF File: 49
Keywords: Hedge funds, Derivatives use, Risk taking, Risk shifting, Liquidation risk, Flow-performance relation
JEL Classification: G11, G23, G34
Date posted: March 25, 2008 ; Last revised: February 8, 2010
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