hedge strongfundstrong tail risk - princeton university.pdf

Hedge Fund Tail Risk Tobias Adriany Markus K. Brunnermeierz Federal Reserve Bank of New York Princeton University Version: September 21, 2007 - Preliminary and Incomplete - Abstract This paper uses quantile regressions to document the increase in hedge funds Value-at-Risk (VaR) conditional on other styles being under distress and (pre- dictable) spill-over eects to the banking sector. This increase of conditional VaR is due to an increase in bivariate dependencies in times of stress. We identify six common factors that explain the tail dependence across hedge fund styles. This set of risk factors also explains a large part of hedge funds expected returns, which unlike the Value-at-Risk, aect ows into and out of hedge funds style. Keywords: Hedge Funds, Tail Risk, Asset Pricing, Systemic Risk, Value-at-Risk JEL classication: G10, G12 The authors would like to thank Rene Carmona, Xavier Gabaix, Beverly Hirtle, John Kambhu, Burton Malkiel, Maureen OHara, Matt Pritsker, Jose Scheinkman, Kevin Stiroh and seminar par- ticipants at Columbia University, Princeton University, Cornell University, Rutgers University, and the Federal Reserve Bank of New York for helpful comments. Brunnermeier acknowledges nancial support from the Alfred P. Sloan Foundation. The views expressed in this paper are those of the authors and do not necessarily represent those of the Federal Reserve Bank of New York or the Federal Reserve System. yFederal Reserve Bank of New York, Capital Markets, 33 Liberty Street, New York, NY 10045, /adrian/, email: tobias.adrian@ zPrinceton University, Department