Predicting Hedge Fund Failure: A Comparison of Risk Measures

Bing Liang · Hyuna Park

144 citations0/0 files storedJournal of Financial and Quantitative Analysis

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Financial Markets and Investment Strategies Financial Risk and Volatility Modeling Risk and Portfolio Optimization

Abstract

Abstract This paper compares downside risk measures that incorporate higher return moments with traditional risk measures such as standard deviation in predicting hedge fund failure. When controlling for investment strategies, performance, fund age, size, lockup, high-water mark, and leverage, we find that funds with larger downside risk have a higher hazard rate. However, standard deviation loses the explanatory power once the other explanatory variables are included in the hazard model. Further, we find that liquidation does not necessarily mean failure in the hedge fund industry. By reexamining the attrition rate, we show that the real failure rate of 3.1% is lower than the attrition rate of 8.7% on an annual basis during the period of 1995–2004.

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References

1999Coherent Measures of Risk 2000Value At Risk: The New Benchmark for Managing Financial Risk 1997Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds 2003Risks and Portfolio Decisions Involving Hedge Funds 1992Survivorship Bias in Performance Studies 1999The Performance of Hedge Funds: Risk, Return, and Incentives 2004An econometric model of serial correlation and illiquidity in hedge fund returns 2000Performance Characteristics of Hedge Funds and Commodity Funds: Natural vs. Spurious Biases

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