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Do Higher-Moment Equity Risks Explain Hedge Fund Returns?

54 Pages Posted: 21 Mar 2008 Last revised: 30 Jan 2011

Vikas Agarwal

Georgia State University; University of Cologne - Centre for Financial Research (CFR)

Gurdip Bakshi

University of Maryland - Robert H. Smith School of Business

Joop Huij

Erasmus University - Rotterdam School of Management; Robeco Quantitative Strategies; Erasmus University Rotterdam (EUR) - Erasmus Research Institute of Management (ERIM)

Date Written: August 6, 2009

Abstract

Hedge funds are fundamentally exposed to equity volatility, skewness, and kurtosis risks based on the systematic pattern and significant spread in alphas from the existing models that do not control for the higher-moment risks. The spread and pattern in alphas do not disappear with bootstrap simulation, Bayesian analysis to account for potential estimation error, adjustment for backfilling bias, and the inclusion of additional systematic factors. Significant cross-sectional variation in higher-moment exposures is observed across fund styles with equity-oriented styles displaying more extreme exposures. Investable higher-moment factors explain the time series behavior of returns of a large number of Managed Futures, Event Driven, and Long/Short Equity hedge funds. Average exposure sensitivities for higher-moment factors are statistically significant in an estimation that accounts for style fixed effects and fund random effects.

Keywords: volatility risk, skewness risk, kurtosis risk, higher moments, exposures, hedge funds, alphas

JEL Classification: G10, G11, G12

Suggested Citation

Agarwal, Vikas and Bakshi, Gurdip and Huij, Joop, Do Higher-Moment Equity Risks Explain Hedge Fund Returns? (August 6, 2009). Robert H. Smith School Research Paper No. RHS 06-153. Available at SSRN: https://ssrn.com/abstract=1108635 or http://dx.doi.org/10.2139/ssrn.1108635

Vikas Agarwal (Contact Author)

Georgia State University ( email )

35 Broad Street,
Suite 1221
Atlanta, GA 30303-3083
United States
404-413-7326 (Phone)
404-413-7312 (Fax)

HOME PAGE: http://www.gsu.edu/~fncvaa

University of Cologne - Centre for Financial Research (CFR)

Albertus-Magnus Platz
Cologne, 50923
Germany

Gurdip S. Bakshi

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-2261 (Phone)
301-314-9157 (Fax)

HOME PAGE: http://scholar.rhsmith.umd.edu/gbakshi/Home?destination=Home

Joop Huij

Erasmus University Rotterdam (EUR) - Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands

HOME PAGE: http://www.rsm.nl/jhuij

Robeco Quantitative Strategies

Rotterdam, 3011 AG
Netherlands

HOME PAGE: http://www.robeco.com/quant

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