Research

J. Joenvaara, M. Kauppila: Hedge Fund Tail Risk: Performance and Hedging Mechanisms

January 15, 2015

We decompose hedge fund tail risk into two components: Systematic Conditional Tail Risk (SCTR), which arises predictably from equity market exposure; and Idiosyncratic Conditional Tail Risk (ICTR), which arises from proprietary alpha investment technology. First, we show that low-SCTR hedge funds deliver superior risk-adjusted returns, but not average returns. In contrast, low-ICTR funds provide both higher risk-adjusted returns and also higher average returns. Our results suggest that this better performance could be due more to skillful hedging than to the harvesting of low-risk anomalies.