Dynamic Trading Strategies of Equity Hedge Funds: Empirical Evidence on How They Adapt to Market Conditions

27 Pages Posted: 12 Jun 2012

See all articles by Aline Muller

Aline Muller

HEC Management School University of Liège; Maastricht University - Limburg Institute of Financial Economics (LIFE)

Marie Lambert

University of Liege - HEC Management School

Hamid Babaei

University of Liege - HEC Management School

Date Written: June 12, 2012

Abstract

Hedge funds shift investment strategies in response to changing market conditions. We adjust hedge fund returns for their risks in an estimation that accounts for regime-switching effects. Index factors are used to capture the returns from buy-and-hold strategies followed by hedge fund. Besides, in order to capture the nonlinear dependence of hedge fund returns on these market indexes, we construct investable higher-moment factors and option-like strategies. Because our trading factors are mostly based on the equity markets, we focus on the equity-oriented hedge funds from the Hedge Fund Research database. Especially, we test whether these factors can explain the time series behavior of returns of a market neutral, short selling and long/short equity hedge funds. Average exposure sensitivities for systematic skewness are statistically significant for all funds. Equity hedge funds are moreover shown to follow a conservative investment strategy as they reduce their (linear or nonlinear) exposures in down-market regime relative to tranquil- or up-market regimes.

Keywords: hedge funds, markov chain, beta regimes, higher moments

JEL Classification: G11, G12

Suggested Citation

Muller, Aline and Lambert, Marie and Babaei, Hamid, Dynamic Trading Strategies of Equity Hedge Funds: Empirical Evidence on How They Adapt to Market Conditions (June 12, 2012). Available at SSRN: https://ssrn.com/abstract=2082878 or http://dx.doi.org/10.2139/ssrn.2082878

Aline Muller (Contact Author)

HEC Management School University of Liège ( email )

B-4000 Liege
Belgium
+3242327435 (Phone)
+3242327376 (Fax)

Maastricht University - Limburg Institute of Financial Economics (LIFE) ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

Marie Lambert

University of Liege - HEC Management School ( email )

HEC-Liège
rue Louvrex 14
LIEGE, Liege 4000
Belgium

Hamid Babaei

University of Liege - HEC Management School ( email )

Liege

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