Implicit Options in Hedge Fund Products
6 Pages Posted: 7 Jun 2015
Date Written: January 27, 2003
This brief paper discusses the option-like exposures of a number of hedge fund strategies based on a review of the literature on the topic. Specifically, recent academic articles have argued that implicit options arise in hedge fund products due to the following factors: (1) the tailoring of return-to-risk profiles to certain classes of investors, resulting in investments that have option-like payoff profiles; (2) the provision of real options by hedge fund investors who take on illiquid investments, allowing other investors the flexibility to readily liquidate their investments; and (3) the incentives given to hedge fund managers in their management contracts, which provide managers with option-like payoff profiles in terms of how they are paid for their services. Accordingly, the paper briefly covers the investor preferences, risk-transfer function, and manager incentives that lead to the implicit optionality embedded in hedge fund products.
Keywords: Hedge Funds, Option-like payoff
JEL Classification: G1, G11, G23
Suggested Citation: Suggested Citation