Abstract

http://ssrn.com/abstract=2019482
 
 

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Tail Risk and Hedge Fund Returns


Bryan T. Kelly


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Hao Jiang


Michigan State University

November 1, 2012

Chicago Booth Research Paper No. 12-44
Fama-Miller Working Paper

Abstract:     
We document large, persistent exposures of hedge funds to downside tail risk. For instance, the hardest hit hedge funds in the 1998 crisis also suffered predictably worse returns than their peers in 2007-2008. Using the conditional tail risk factor derived by Kelly (2012), we find that tail risk is a key driver of hedge fund returns in both the time-series and cross-section. A positive one standard deviation shock to tail risk is associated with a contemporaneous decline of 2.88% per year in the value of the aggregate hedge fund portfolio. In the cross-section, funds that lose value during high tail risk episodes earn average annual returns more than 6% higher than funds that are tail risk-hedged, controlling for commonly used hedge fund factors. These results are consistent with the notion that a significant component of hedge fund returns can be viewed as compensation for selling disaster insurance.

Number of Pages in PDF File: 42

Keywords: Hedge fund, tail risk, performance evaluation

JEL Classification: G12, G20

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Date posted: May 31, 2012 ; Last revised: November 20, 2012

Suggested Citation

Kelly, Bryan T. and Jiang, Hao, Tail Risk and Hedge Fund Returns (November 1, 2012). Chicago Booth Research Paper No. 12-44; Fama-Miller Working Paper. Available at SSRN: http://ssrn.com/abstract=2019482 or http://dx.doi.org/10.2139/ssrn.2019482

Contact Information

Bryan T. Kelly (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-8359 (Phone)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Hao Jiang
Michigan State University ( email )
315 Eppley Center
Department of Finance
East Lansing, MI 48824
United States
HOME PAGE: http://sites.google.com/site/haojiangfinance/
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