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Fat Tail Risk in Portfolios of Hedge Funds and Traditional Investments

Jean-Francois Bacmann

RMF Investment Management

Gregor Gawron

RMF Investment Products

January 2004

EFMA 2004 Basel Meetings Paper

We analyse the risk of portfolios mixing hedge funds, stocks and bonds. The risk of the portfolios is quantified by the Value-at-Risk and the Expected Shortfall derived from the Extreme Value Theory. This approach enables us to take the impact of higher moments into account. We show that the risk of a traditional portfolio is reduced by the inclusion of hedge funds. An optimal weight of 50% hedge funds is found when the traditional portfolio is mostly composed of bonds. In equity dominated portfolios, investors should incorporate as much hedge funds as possible. Furthermore we examine the extremal dependence between funds of hedge funds and stocks or bonds using multivariate Extreme Value Theory. We do not find any significant extremal dependence between hedge funds and bonds. The evidence is more mixed between stocks and funds of hedge funds. Funds of hedge funds without a significant investment in Managed Futures exhibit significant dependence in the extreme with the stock market. The August 1998 event linked to the Russian crisis and the LTCM failure is the cause of this dependence.

Number of Pages in PDF File: 29

Keywords: hedge funds, higher moments, extreme value theory, VaR, Expected shortfall

JEL Classification: C13, C22, G11

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Date posted: May 9, 2004  

Suggested Citation

Bacmann, Jean-Francois and Gawron, Gregor, Fat Tail Risk in Portfolios of Hedge Funds and Traditional Investments (January 2004). EFMA 2004 Basel Meetings Paper. Available at SSRN: https://ssrn.com/abstract=492643 or http://dx.doi.org/10.2139/ssrn.492643

Contact Information

Jean-Francois Bacmann (Contact Author)
RMF Investment Management ( email )
Huobstrasse 16
8808 Pfaeffikon SZ
41 55 417 77 10 (Phone)
41 55 417 77 11 (Fax)
Gregor Gawron
RMF Investment Products ( email )
Huobstrasse 16
8808 Pfaeffikon SZ
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