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Zero-R2 Hedge Funds and Market Neutrality

Nicolas P. B. Bollen

Vanderbilt University - Finance

October 28, 2011

Factor models yield an R2 insignificantly different from zero for one-third of hedge funds in a broad sample. These funds illustrate the concept of market neutrality and feature lower volatilities, higher Sharpe ratios, and higher alphas than other funds, indicating they provide a successful alternative investment. However, large portfolios of zero-R2 funds contain fully half the volatility of portfolios of other funds, suggesting they feature substantial systematic risk. Furthermore, these funds display an increased probability of failure even after controlling for idiosyncratic volatility. These results indicate the presence of an omitted factor that exposes investors to significant downside risk.

Number of Pages in PDF File: 48

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Date posted: March 2, 2011 ; Last revised: November 17, 2012

Suggested Citation

Bollen, Nicolas P. B., Zero-R2 Hedge Funds and Market Neutrality (October 28, 2011). Available at SSRN: https://ssrn.com/abstract=1773675 or http://dx.doi.org/10.2139/ssrn.1773675

Contact Information

Nicolas P.B. Bollen (Contact Author)
Vanderbilt University - Finance ( email )
401 21st Avenue South
Nashville, TN 37203
United States
HOME PAGE: http://mba.vanderbilt.edu/faculty/nbollen.cfm

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References:  41
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