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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.
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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 

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