Hedge fund tail risk: An investigation in stressed markets

The financial industry has witnessed several crises in the past, some of which have had a major global impact. Although hedge funds are expected to have the capability to at least avoid the impact of such crises by hedging against market movements, the long-term capital management crisis in 1998 and the global meltdown in 2008 showed otherwise. In both cases, most hedge funds suffered large losses; In fact, almost all Dow Jones Credit Suisse hedge fund indexes experienced huge losses. These systemic losses have been associated mostly with large, simultaneous liquidation by market participants, causing a liquidity freeze that crippled hedge funds and spilled over to the general economy (see Brown et al. [2009]; Buraschi, Kosowski, and Trojani [2014]; and Lo, Getmansky, and Lee [2015]). The experiences from these crises have motivated investors, academics, and regulators to better understand systemic risk in hedge funds and these funds' contribution to the overall risk of a portfolio (see Billio et al. [2012a, b]).