Hedge Fund Risk Factors and Value at Risk of Credit Trading Strategies

63 Pages Posted: 28 Nov 2003  

John Okunev

Coda Asset Management

Derek R. White

UNSW Australia Business School, School of Banking and Finance

Date Written: October 2003

Abstract

This paper analyzes the risk characteristics for various hedge fund strategies specializing in fixed income instruments. Because fixed income hedge fund strategies have exceptionally high autocorrelations in reported returns and this is taken as evidence of return smoothing, we first develop a method to completely eliminate any order of autocorrelation process across a wide array of time series processes. Once this is complete, we determine the underlying risk factors to the "true" hedge fund returns and examine the incremental benefit attained from using nonlinear payoffs relative to the more traditional linear factors. For a great many of the hedge fund indices we find the strongest risk factor to be equivalent to a short put position on high-yield debt. In general, we find a moderate benefit to using the nonlinear risk factors in terms of the ability to explain reported returns. However, in some cases this fit is not stable even over the in-sample period. Finally, we examine the benefit to using various factor structures for estimating the value-at-risk of the hedge funds. We find, in general, that using nonlinear factors slightly increases the estimated downside risk levels of the hedge funds due to their option-like payoff structures.

Keywords: Hedge Funds, Value at Risk

JEL Classification: G1

Suggested Citation

Okunev, John and White, Derek R., Hedge Fund Risk Factors and Value at Risk of Credit Trading Strategies (October 2003). Available at SSRN: https://ssrn.com/abstract=460641 or http://dx.doi.org/10.2139/ssrn.460641

John Okunev (Contact Author)

Coda Asset Management ( email )

10 Arnold St
Queens park
Sydney, 2022
Australia
+61266744575 (Phone)

Derek White

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia
+61 2 9385 5850 (Phone)
+61 2 9385 6347 (Fax)

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