Volatility of aggregate volitility and cross-section of hedge fund returns
Subject
Finance
Publishing details
IFA Working Paper
Authors / Editors
Agarwal V; Erisoy E; Naik N
Biographies
Publication Year
2014
Abstract
This paper investigates empirically whether uncertainty about expected stock returns can explain the performance of hedge funds both in the cross-section and over time. We measure uncertainty via volatility of aggregate volatility (VOV) and construct an investable version of this measure by computing monthly returns on lookback straddles written 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 individual fund level. We find that funds with low (more negative) VOV betas outperform funds with high VOV betas by 1.61% per month. 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 funds with low VOV betas outperform their counterparts during the financial crisis period when uncertainty about expected returns was at its highest. On the contrary, funds with high VOV betas generate superior returns when uncertainty in the market is less.
Keywords
Uncertainty; Volatility of volatility; Hedge funds; Performance
Series
IFA Working Paper