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RFS Advance Access published online on October 15, 2003
Review of Financial Studies, doi:10.1093/rfs/hhg044
Review of Financial Studies © The Society for Financial Studies 2003; all rights reserved
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© 2003 The Society for Financial Studies

Original Articles

Risks and Portfolio Decisions Involving Hedge Funds

Vikas Agarwal 1 and Narayan Y. Naik 2*
1 Georgia State University
2 London Business School

* To whom correspondence should be addressed. E-mail: nnaik{at}london.edu.


  Abstract

This paper characterizes the systematic risk exposures of hedge funds using buy-and-hold and option-based strategies. Our results show that a large number of equity-oriented hedge fund strategies exhibit payoffs resembling a short position in a put option on the market index, and therefore bear significant left-tail risk, risk that is ignored by the commonly used mean-variance framework. Using a mean-conditional Value-at-Risk framework, we demonstrate the extent to which the mean-variance framework underestimates the tail risk. Finally, working with the systematic risk exposures of hedge funds, we show that their recent performance appears significantly better than their long-run performance.


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