Estimating Operational Risk for Hedge Funds: The ω-Score

23 Pages Posted: 25 Jan 2008 Last revised: 11 Sep 2009

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)

Bing Liang

University of Massachusetts Amherst - Department of Finance

Christopher Schwarz

University of California at Irvine

Date Written: May 2008

Abstract

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.

Keywords: mutual funds, hedge funds, investments, the Omega Score

Suggested Citation

Brown, Stephen J. and Goetzmann, William N. and Liang, Bing and Schwarz, Christopher, Estimating Operational Risk for Hedge Funds: The ω-Score (May 2008). Yale ICF Working Paper No. 08-08. Available at SSRN: https://ssrn.com/abstract=1086341

Stephen J. Brown (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0306 (Phone)
212-995-4233 (Fax)

William N. Goetzmann

Yale School of Management - International Center for Finance ( email )

165 Whitney Ave.
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-5950 (Phone)
203-436-9252 (Fax)

HOME PAGE: http://viking.som.yale.edu

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Bing Liang

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States

Christopher Schwarz

University of California at Irvine ( email )

Irvine, CA 92697-3125
United States

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