Risk Management for Hedge Funds with Position Information

20 Pages Posted: 13 Mar 2007  

Philippe Jorion

University of California, Irvine - Paul Merage School of Business

Date Written: December 2006

Abstract

Risk management is a challenge for hedge funds because traditional risk measurement methods based on return data are unreliable with dynamic trading strategies. This paper illustrates how Value at Risk (VAR) methods can be used to measure and control the market risk of hedge funds. VAR methods have two key features: (1) they are based on current position information, and (2) they focus on a lower quantile of the distribution of losses or some other risk metric. For rapidly changing positions, VAR should be measured at frequent interval, as is done for banks' proprietary trading portfolios. This paper demonstrates the usefulness of dynamic risk measures for a hypothetical hedge fund with short option positions, which are equivalent to dynamic trading. Imposing daily ex ante VAR limits using position information can be very successful at controlling realized risk.

Keywords: G11, G23, G32

JEL Classification: risk management, hedge funds, value at risk

Suggested Citation

Jorion, Philippe, Risk Management for Hedge Funds with Position Information (December 2006). Available at SSRN: https://ssrn.com/abstract=969988 or http://dx.doi.org/10.2139/ssrn.969988

Philippe Jorion (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Campus Drive
Irvine, CA 92697-3125
United States
949-824-5245 (Phone)
949-824-8469 (Fax)

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