a primer on hedge strongfundsstrong.pdf

Journal of Empirical Finance 6 1999 309–331 locateeconbase A primer on hedge funds William Fung a , David A. Hsieh b, a Paradigm Financial Products International, Wilmington, DE, USA b Fuqua School of Business, Duke Uniersity, Box 90120, Durham, NC 27708-0120, USA Received 1 March 1999; accepted 1 June 1999 Abstract In this paper, we provide a rationale for how hedge funds are organized and some insight on how hedge fund performance differs from traditional mutual funds. Statistical differences among hedge fund styles are used to supplement qualitative differences in the way hedge fund strategies are described. Risk factors associated with different trading styles are discussed. We give examples where standard linear statistical techniques are unlikely to capture the risk of hedge fund investments where the returns are primarily driven by non-linear dynamic strategies. 1999 Elsevier Science B.V. All rights reserved. JEL classification: G20; G23; G28 Keywords: Hedge funds; Mutual funds; Risk factors 1. Introduction Institutional investors and wealthy individuals have long been interested in hedge funds as alternative investments to traditional portfolios of assets. For over half a century of its existence, the hedge fund industry has stayed opaque to the general investing public. Increasingly, spectacular hedge fund activities in the last decade, such as the attack on the British Pound led by George Soros and the recent collapse of Long-Term Capital which prompted the intervention from federal regulators, have heightened the public’s interest in the hedge fund industry. The Corresponding author. Tel.: 1-919-660-7779; fax: 1-9