Hostname: page-component-cd9895bd7-fscjk Total loading time: 0 Render date: 2024-12-26T23:25:13.120Z Has data issue: false hasContentIssue false
  • English
  • Français

Zero-R2Hedge Funds and Market Neutrality

Published online by Cambridge University Press:  14 March 2013

Nicolas P. B. Bollen
Nicolas P. B. Bollen*
Affiliation:
nick.bollen@owen.vanderbilt.edu, Owen Graduate School of Management, Vanderbilt University, 401 21st Ave S, Nashville, TN 37203.
Get access Rights & Permissions [Opens in a new window]

Abstract

Factor models yield an R2 insignificantly different from 0 for one-third of hedge funds in a broad sample. These funds illustrate the concept of market neutrality and feature lower volatilities, higher Sharpe ratios, and higher alphas than other funds, indicating that they provide a successful alternative investment. However, large portfolios of zero-R2 funds contain fully half the volatility of portfolios of other funds, suggesting that they feature substantial systematic risk. Furthermore, these funds display an increased probability of failure even after controlling for idiosyncratic volatility. These results indicate the presence of an omitted factor that exposes investors to significant downside risk.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 2 , April 2013 , pp. 519 - 547
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Ackermann, C.; McEnally, R.; and Ravenscraft, D.. “The Performance of Hedge Funds: Risk, Return, and Incentives.” Journal of Finance, 54 (1999), 833–874.CrossRefGoogle Scholar
Agarwal, V.; Fos, V.; and Jiang, W.. “Inferring Reporting-Related Biases in Hedge Fund Databases from Hedge Fund Equity Holdings.” Management Science, forthcoming (2013).CrossRefGoogle Scholar
Agarwal, V.; Fung, W.; Loon, Y.; and Naik, N.. “Risk and Return in Convertible Arbitrage: Evidence from the Convertible Bond Market.” Journal of Empirical Finance, 18 (2011), 175–194.CrossRefGoogle Scholar
Agarwal, V., and Naik, N.. “Risks and Portfolio Decisions Involving Hedge Funds.” Review of Financial Studies, 17 (2004), 63–98.CrossRefGoogle Scholar
Ali, M., and Sharma, S.. “Robustness to Nonnormality of Regression F-Tests.” Journal of Econometrics, 71 (1996), 175–205.CrossRefGoogle Scholar
Bali, T.; Brown, S.; and Caglayan, M.. “Systematic Risk and the Cross Section of Hedge Fund Returns.” Journal of Financial Economics, 106 (2012), 114–131.CrossRefGoogle Scholar
Bollen, N., and Pool, V.. “Do Hedge Fund Managers Misreport Returns? Evidence from the Pooled Distribution.” Journal of Finance, 64 (2009), 2257–2288.CrossRefGoogle Scholar
Bollen, N., and Whaley, R.. “Hedge Fund Risk Dynamics: Implications for Performance Appraisal.” Journal of Finance, 64 (2009), 985–1035.CrossRefGoogle Scholar
Brown, S.; Gregoriou, G.; and Pascalau, R.. “Diversification in Funds of Hedge Funds: Is It Possible to Overdiversify?” Review of Asset Pricing Studies, 2 (2011), 89–110.CrossRefGoogle Scholar
Brunnermeier, M., and Nagel, S.. “Hedge Funds and the Technology Bubble.” Journal of Finance, 59 (2004), 2013–2040.CrossRefGoogle Scholar
Buraschi, A.; Kosowski, R.; and Trojani, F.. “When There Is No Place to Hide: Correlation Risk and the Cross-Section of Hedge Fund Returns.” Working Paper, Imperial College London (2010).CrossRefGoogle Scholar
Carhart, M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Cassar, G., and Gerakos, J.. “Hedge Funds: Pricing Controls and the Smoothing of Self-Reported Returns.” Review of Financial Studies, 24 (2011), 1698–1734.CrossRefGoogle Scholar
Cremers, K., and Petajisto, A.. “How Active Is Your Fund Manager? A New Measure That Predicts Performance.” Review of Financial Studies, 22 (2009), 3329–3365.CrossRefGoogle Scholar
Duarte, J.; Longstaff, F.; and Yu, F.. “Risk and Return in Fixed Income Arbitrage: Nickels in Front of a Steamroller?” Review of Financial Studies, 20 (2007), 769–811.CrossRefGoogle Scholar
Evans, R. “Mutual Fund Incubation.” Journal of Finance, 65 (2010), 1581–1611.CrossRefGoogle Scholar
Foster, F.; Smith, T.; and Whaley, R.. “Assessing Goodness-of-Fit of Asset Pricing Models: The Distribution of the Maximal R 2.” Journal of Finance, 52 (1997), 591–607.Google Scholar
Fung, W., and Hsieh, D.. “Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds.” Review of Financial Studies, 10 (1997), 275–302.CrossRefGoogle Scholar
Fung, W., and Hsieh, D.. “The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers.” Review of Financial Studies, 14 (2001), 313–341.CrossRefGoogle Scholar
Fung, W., and Hsieh, D.. “Hedge Fund Benchmarks: A Risk-Based Approach.” Financial Analysts Journal, 60 (2004), 65–80.CrossRefGoogle Scholar
Fung, W.; Hsieh, D.; Naik, N.; and Ramadorai, T.. “Hedge Funds: Performance, Risk, and Capital Formation.” Journal of Finance, 63 (2008), 1777–1803.CrossRefGoogle Scholar
Getmansky, M.; Lo, A.; and Makarov, I.. “An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns.” Journal of Financial Economics, 74 (2004), 529–609.CrossRefGoogle Scholar
Grecu, A.; Malkiel, B.; and Saha, A.. “Why Do Hedge Funds Stop Reporting Their Performance?” Journal of Portfolio Management, 34 (2007), 119–126.CrossRefGoogle Scholar
Griffin, J., and Xu, J.. “How Smart Are the Smart Guys? A Unique View from Hedge Fund Stock Holdings.” Review of Financial Studies, 22 (2009), 2331–2370.CrossRefGoogle Scholar
Jagannathan, R.; Malakhov, A.; and Novikov, D.. “Do Hot Hands Exist among Hedge Fund Managers? An Empirical Evaluation.” Journal of Finance, 65 (2010), 217–255.CrossRefGoogle Scholar
Kosowski, R.; Naik, N.; and Teo, M.. “Do Hedge Funds Deliver Alpha? A Bayesian and Bootstrap Analysis.” Journal of Financial Economics, 84 (2007), 229–264.CrossRefGoogle Scholar
Liang, B. “On the Performance of Hedge Funds.” Financial Analysts Journal, 55 (1999), 72–85.CrossRefGoogle Scholar
Liang, B., and Park, H.. “Predicting Hedge Fund Failure: A Comparison of Risk Measures.” Journal of Financial and Quantitative Analysis, 45 (2010), 199–222.CrossRefGoogle Scholar
Pástor, L., and Stambaugh, R.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.CrossRefGoogle Scholar
Patton, A. “Are ‘Market Neutral’ Hedge Funds Really Market Neutral?” Review of Financial Studies, 22 (2009), 2495–2530.CrossRefGoogle Scholar
Patton, A., and Ramadorai, T.. “On the High-Frequency Dynamics of Hedge Fund Risk Exposures.” Journal of Finance, 68 (2013), 597–635.CrossRefGoogle Scholar
Pontiff, J. “Costly Arbitrage: Evidence from Closed-End Funds.” Quarterly Journal of Economics, 111 (1996), 1135–1151.CrossRefGoogle Scholar
Pontiff, J. “Costly Arbitrage and the Myth of Idiosyncratic Risk.” Journal of Accounting and Economics, 42 (2006), 35–52.CrossRefGoogle Scholar
Sharpe, W. “Asset Allocation: Management Style and Performance Measurement.” Journal of Portfolio Management, 18 (1992), 7–19.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.CrossRefGoogle Scholar
Sun, Z.; Wang, A.; and Zheng, L.. “The Road Less Traveled: Strategy Distinctiveness and Hedge Fund Performance.” Review of Financial Studies, 25 (2012), 96–143.CrossRefGoogle Scholar
Titman, S., and Tiu, C.. “Do the Best Hedge Funds Hedge?” Review of Financial Studies, 24 (2011), 123–168.CrossRefGoogle Scholar
White, H. “Maximum Likelihood Estimation of Misspecified Models.” Econometrica, 50 (1982),1–25.CrossRefGoogle Scholar
White, H. “A Reality Check for Data Snooping.” Econometrica, 68 (2000), 1097–1126.CrossRefGoogle Scholar