When There is No Place to Hide - Correlation Risk and the Cross-Section of Hedge Fund Returns
The University of Chicago; Imperial College Business School; Centre for Economic Policy Research (CEPR)
Imperial College Business School; CEPR (Centre for Economic Policy Research); University of Oxford, Oxford-Man Institute of Quantitative Finance
University of Geneva; Swiss Finance Institute
Using a novel dataset on correlation swaps, we study the relation between correlation risk, hedge fund characteristics and their risk-return profile. We find that hedge funds' ability to create market neutral returns is often associated with a significant exposure to correlation risk, which helps to explain the large abnormal returns found in previous models. We also estimate a significant negative market price of correlation risk, which accounts for the cross-section of hedge fund excess returns. Finally, we detect a pronounced nonlinear relation between correlation risk exposure and the tail risk of hedge fund returns.
Number of Pages in PDF File: 80
Keywords: Stochastic Correlation and Volatility, Hedge Fund Performance, Optimal Portfolio Choice
JEL Classification: D9, E3, E4, G11, G14, G23
Date posted: July 15, 2010 ; Last revised: November 16, 2013
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