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Crises and Hedge Fund Risk

61 Pages Posted: 20 May 2008 Last revised: 25 Apr 2012

Monica Billio

Ca Foscari University of Venice - Dipartimento di Economia

Mila Getmansky

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Ca Foscari University of Venice

Multiple version iconThere are 2 versions of this paper

Date Written: July 18, 2010

Abstract

We study the effect of financial crises on hedge fund risk. Using a regime-switching beta model, we separate systematic and idiosyncratic components of hedge fund exposure. The systematic exposure to various risk factors is conditional on market volatility conditions. We find that in the high-volatility regime (when the market is rolling-down and is likely to be in a crisis state) most strategies are negatively and significantly exposed to the Large-Small and Credit Spread risk factors. This suggests that liquidity risk and credit risk are potentially common factors for different hedge fund strategies in the down-state of the market, when volatility is high and returns are very low. We further explore the possibility that all hedge fund strategies exhibit a high volatility regime of the idiosyncratic risk, which could be attributed to contagion among hedge fund strategies. In our sample this event happened only during the Long-Term Capital Management (LTCM) crisis of 1998. Other crises including the recent subprime mortgage crisis affected hedge funds only through systematic risk factors, and did not cause contagion among hedge funds.

Keywords: Hedge Fund, Risk Management, Financial Crisis

JEL Classification: G12, G29, C51

Suggested Citation

Billio, Monica and Getmansky, Mila and Pelizzon, Loriana, Crises and Hedge Fund Risk (July 18, 2010). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 10-08; UMASS-Amherst Working Paper; Yale ICF Working Paper No. 07-14; University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 10-08. Available at SSRN: https://ssrn.com/abstract=1130742 or http://dx.doi.org/10.2139/ssrn.1130742

Monica Billio (Contact Author)

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

HOME PAGE: http://www.unive.it/persone/billio

Mila Getmansky Sherman

University of Massachusetts at Amherst - Eugene M. Isenberg School of Management - Department of Finance ( email )

Amherst, MA 01003-4910
United States

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

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