Do Hedge Funds’ Exposures to Risk Factors Predict Their Future Returns?
Turan G. Bali
Georgetown University - Robert Emmett McDonough School of Business
Stephen J. Brown
New York University - Stern School of Business
Mustafa O. Caglayan
October 26, 2010
This paper investigates hedge funds’ exposures to various financial and macroeconomic risk factors through alternative measures of factor betas and examines their performance in predicting the cross-sectional variation in hedge fund returns. Both parametric and nonparametric tests indicate a significantly positive (negative) link between default premium beta (inflation beta) and future hedge fund returns. The results are robust across different subsample periods and states of the economy, and after controlling for market, size, book-to-market, and momentum factors as well as the trend-following factors in stocks, short-term interest rates, currencies, bonds, and commodities. The paper also provides macro and micro level explanations of our findings.
Number of Pages in PDF File: 66
Keywords: Hedge Funds, Return Predictability, Risk Factors
JEL Classification: G10, G11, C13
Date posted: February 18, 2010 ; Last revised: February 27, 2012