Measuring Loss Potential of Hedge Fund Strategies

25 Pages Posted: 4 Jan 2005

See all articles by Marcos Lopez de Prado

Marcos Lopez de Prado

Cornell University - Operations Research & Industrial Engineering; Abu Dhabi Investment Authority; True Positive Technologies

Achim Peijan

UBS Wealth Managment Research

Abstract

We measure the loss potential of Hedge Funds by combining three market risk measures: VaR, Draw-Down and Time Under-The-Water. Calculations are carried out considering three different frameworks regarding Hedge Fund returns: i) Normality and time-independence, ii) Non-normality and time-independence and iii) Non-normality and time-dependence.

In the case of Hedge Funds, our results clearly state that market risk may be substantially underestimated by those models which assume Normality or, even considering Non-Normality, neglect to model time-dependence. Moreover, VaR is an incomplete measure of market risk whenever the Normality assumption does not hold. In this case, VaR results must be compared with Draw-Down and Time Under-The-Water measures in order to accurately assess about Hedge Funds loss potential.

Keywords: Hedge Fund, Value-at-Risk, risk, performance, drawdown, under-the-water, normal returns, non-normal returns, time-dependence, ARMA, Monte Carlo, skewness, kurtosis, mixture of gaussian distributions, survival probability, styles, investment strategies

JEL Classification: G0, G1, G2, G15, G24, E44

Suggested Citation

López de Prado, Marcos and López de Prado, Marcos and Peijan, Achim, Measuring Loss Potential of Hedge Fund Strategies. Available at SSRN: https://ssrn.com/abstract=641702

Marcos López de Prado (Contact Author)

Cornell University - Operations Research & Industrial Engineering ( email )

237 Rhodes Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.orie.cornell.edu

Abu Dhabi Investment Authority ( email )

211 Corniche Road
Abu Dhabi, Abu Dhabi PO Box3600
United Arab Emirates

HOME PAGE: http://www.adia.ae

True Positive Technologies ( email )

NY
United States

HOME PAGE: http://www.truepositive.com

Achim Peijan

UBS Wealth Managment Research ( email )

Zurich, CH-8098
Switzerland

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