Publication Type

Working Paper

Publication Date

4-2008

Abstract

In this paper, we examine higher-moment market risks in the cross-section of hedge fund returns to make several contributions. First, we show that hedge funds are substantially exposed to the three highermoment risks - volatility, skewness, and kurtosis. In contrast, mutual funds do not display meaningful dispersions in their exposures to these risks. Further, funds of hedge funds when examined as a separate investment category do not show aggressive loading on higher-moment risks. Second, we provide evidence on economically significant premiums being embedded in hedge fund returns on account of their exposures to higher-moment risks. Third, we uncover a set of higher-moment factors that are not strongly associated with factors in benchmark models that are currently used for evaluating hedge fund performance. Finally, the addition of these higher-moment factors to benchmark models can better explain the variation in hedge fund returns. Bearing on issues of practical consequence, we find that benchmark models augmented with higher-moment factors can considerably alter the hedge funds’ alpha-based rankings.

Keywords

Volatility Risk, Skewness Risk, Kurtosis Risk, Higher Moments, Exposures, Hedge Funds, Alphas

Discipline

Portfolio and Security Analysis

Research Areas

Financial Economics

Publisher

Singapore Management University, BNP Paribas Hedge Fund Centre

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