Hedge Funds Essay

11188 Words Feb 28th, 2011 45 Pages
Do Hedge Funds Have Enough Capital? A Value-at-Risk Approach *

Anurag Gupta† Bing Liang‡

April 2004

____________________________________ *We thank Stephen Brown, Sanjiv Das, Will Goetzmann, David Hseih, Kasturi Rangan, Peter Ritchken, Bill Sharpe, Ajai Singh, Jack Treynor, and two anonymous referees for comments and suggestions on earlier drafts, and the seminar participants at Case Western Reserve University, University of Massachusetts at Amherst, Virginia Tech., the 2003 European Finance Association Meetings in Glasgow, the 2003 Western Finance Association Meetings in Los Cabos, the 2003 QGroup fall seminar in Scottsdale, the 2001 FMA European Meetings in Paris, and the 2001 FMA meetings in Toronto. Bing Liang acknowledges a
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Traditional risk measures like standard deviation or leverage ratios fail to detect these trends. JEL Classification: G23; G28; G29 Keywords: Hedge funds; Value-at-Risk; Capital adequacy; Extreme value theory; Monte Carlo simulation.



The hedge fund industry is one of the fastest growing sectors in finance, due to limited regulatory oversight, flexible investment strategies, and performance based fee structures. The rapid growth in this area has captured the attention of both academics and practitioners. This has led to several studies that analyze hedge fund performance, examine survivorship bias issues, and investigate the reasons for differences in fund performance across styles. These studies include Fung and Hsieh (1997), who argue that the highly dynamic hedge fund investment strategies can provide an integrated framework for style analysis. Brown, Goetzmann, and Ibbotson (1999) examine the performance of offshore hedge funds and attribute their performance to style effects rather than managerial skills. Ackermann, McEnally, and Ravenscraft (1999) conclude that hedge funds outperform mutual funds. Liang (1999) finds that hedge fund investment strategies are different from those of mutual funds. Agarwal and Naik (2003) propose a general asset class factor model comprising of option-based and buy-and-hold strategies to benchmark hedge fund performance. All of the above studies analyze hedge fund performance relative to certain

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