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Volatility of Aggregate Volatility and Hedge Fund Returns

Agarwal, Vikas; Arisoy, Eser; Naik, Narayan Y. (2015), Volatility of Aggregate Volatility and Hedge Fund Returns, 5th International Conference of the Financial Engineering and Banking Society (FEBS 2015), 2015-06, Nantes, France

Type
Communication / Conférence
Date
2015
Conference title
5th International Conference of the Financial Engineering and Banking Society (FEBS 2015)
Conference date
2015-06
Conference city
Nantes
Conference country
France
Pages
64
Publication identifier
10.2139/ssrn.2502352
Metadata
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Author(s)
Agarwal, Vikas

Arisoy, Eser
Dauphine Recherches en Management [DRM]
Naik, Narayan Y.
Abstract (EN)
This paper investigates empirically whether uncertainty about volatility of the market portfolio can explain the performance of hedge funds both in the cross-section and over time. We measure uncertainty about volatility of the market portfolio via volatility of aggregate volatility (VOV) and construct an investable version of this measure by computing monthly returns on lookback straddles on the VIX index. We find that VOV exposure is a significant determinant of hedge fund returns at the overall index level, at different strategy levels, and at an individual fund level. After controlling for a large set of fund characteristics, we document a robust and significant negative risk premium for VOV exposure in the cross-section of hedge fund returns. We further show that strategies with less negative VOV betas outperform their counterparts during the financial crisis period when uncertainty was at its highest. On the contrary, strategies with more negative VOV betas generate superior returns when uncertainty in the market is less. Finally, we demonstrate that VOV exposure-return relationship of hedge funds is distinct from that of mutual funds and is consistent with the dynamic trading of hedge funds and risk-taking incentives arising from performance-based compensation of hedge funds.
Subjects / Keywords
Uncertainty; Volatility of volatility; Hedge funds; Performance
JEL
G10 - General
C13 - Estimation: General
G11 - Portfolio Choice; Investment Decisions
M41 - Accounting

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