Extremal Connectedness and Systemic Risk of Hedge Funds

35 Pages Posted: 7 Feb 2020

See all articles by Linda Mhalla

Linda Mhalla

HEC Montreal - Department of Decision Sciences; University of Geneva, Geneva School of Economics and Management, Research Center for Statistics

Julien Hambuckers

University of Liege - HEC Management School; University of Goettingen

Marie Lambert

University of Liege - HEC Management School

Date Written: January 14, 2020

Abstract

In this paper, we study the connectedness between extreme losses of hedge funds, a crucial feature for systemic risk management. To do so, we exploit cross-sections of hedge funds monthly returns grouped by investment styles, and build a time-varying measure of tail dependence across styles. Relying on extreme value theory and regression techniques, we study the dynamics of the tail dependencies between fund styles conditional on factors reflecting the economic uncertainty and the stock market performance. The resulting tail dependence measures are used to construct a time-varying network between extreme losses of the various investment styles. We show that during a crisis period, while the extremal dependence between some pairs of investment styles remains stable, other pairs show a striking increase of their extremal connectedness. Our results highlight that a proactive regulatory framework should account for the dynamic nature of the tail dependence and its link with financial stress.

Keywords: extreme value theory, hedge funds, systemic risk, tail dependence

JEL Classification: C56, C48, G01, G23

Suggested Citation

Mhalla, Linda and Hambuckers, Julien and Lambert, Marie, Extremal Connectedness and Systemic Risk of Hedge Funds (January 14, 2020). Available at SSRN: https://ssrn.com/abstract=3519295 or http://dx.doi.org/10.2139/ssrn.3519295

Linda Mhalla

HEC Montreal - Department of Decision Sciences ( email )

3000 Côte-Sainte-Catherine Road
Montreal, QC H2S1L4
Canada

University of Geneva, Geneva School of Economics and Management, Research Center for Statistics ( email )

Geneva
Switzerland
+41 379 82 12 (Phone)

Julien Hambuckers (Contact Author)

University of Liege - HEC Management School ( email )

rue Louvrex 14
Liege, Liege 4000
Belgium

University of Goettingen ( email )

Platz der Gottinger Sieben 3
Gottingen, D-37073
Germany

Marie Lambert

University of Liege - HEC Management School ( email )

HEC-Liège
rue Louvrex 14
LIEGE, Liege 4000
Belgium

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