Hedge Fund Tail Risk: Hedging Mechanisms and Performance

57 Pages Posted: 15 Jan 2015 Last revised: 21 Sep 2016

See all articles by Juha Joenväärä

Juha Joenväärä

Aalto University School of Business

Mikko Kauppila

University of Oulu

Date Written: September 19, 2016

Abstract

We decompose hedge fund tail risk into two components: Systematic Conditional Tail Risk (SCTR) arising predictably from equity market exposure, and Idiosyncratic Conditional Tail Risk (ICTR) arising from proprietary investment technology. Using option holdings data, we demonstrate that low-SCTR funds mechanically use protective options. Low-ICTR funds seem to pose tail risk hedging skills, because they use protective options heavily only during the times of market stress. Low-ICTR (Low-SCTR) funds (do not) deliver superior performance. Our results hold after controlling for performance measure manipulation, nonlinearities and autocorrelation in fund returns, and cannot be subsumed by existing skill or risk measures.

Keywords: hedge fund performance, tail risk, options, hedging, low-risk anomaly

JEL Classification: G11, G12, G23

Suggested Citation

Joenvaara, Juha and Kauppila, Mikko, Hedge Fund Tail Risk: Hedging Mechanisms and Performance (September 19, 2016). Available at SSRN: https://ssrn.com/abstract=2549513 or http://dx.doi.org/10.2139/ssrn.2549513

Juha Joenvaara (Contact Author)

Aalto University School of Business ( email )

Finland

Mikko Kauppila

University of Oulu ( email )

P.O. Box 4600
Oulu FIN-90014, 90570
Finland

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