When There Is No Place to Hide - Correlation Risk and the Cross-Section of Hedge Fund Returns
Review of Financial Studies, 2014, Vol. 27 No.2, 581-616
Posted: 12 Oct 2013 Last revised: 8 Apr 2014
Date Written: September 27, 2013
Using a novel dataset on correlation swaps, we study the relation between correlation risk, hedge fund characteristics and their risk-return profile. We find that hedge funds' ability to create market neutral returns is often associated with a significant exposure to correlation risk, which helps to explain the large abnormal returns found in previous models. We also estimate a significant negative market price of correlation risk, which accounts for the cross-section of hedge fund excess returns. Finally, we detect a pronounced nonlinear relation between correlation risk exposure and the tail risk of hedge fund returns.
Keywords: Stochastic Correlation and Volatility, Hedge Fund Performance, Optimal Portfolio Choice
JEL Classification: D9, E3, E4, G11, G14, G23
Suggested Citation: Suggested Citation