Value at risk, GARCH modelling and the forecasting of hedge fund return volatility
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r Roland Fu¨ss is Lecturer at the Department of Empirical Research and Econometrics and Assistant Professor at the Department of Finance and Banking at the University of Freiburg, Germany. He holds an MBA from the University of Applied Science in Lo¨rrach, M.Ec. and PhD degree in Economics from the University of Freiburg. His research interests are in the field of applied econometrics, alternative investments as well as international and real estate finance. He has (co-) authored several articles in finance journals and book chapters. Further, he is a member of the Verein fu¨r Socialpolitik and of the German Finance Association. Dieter G. Kaiser is responsible for the institutional research at Benchmark Alternative Strategies in Frankfurt, Germany. He has worked for Dresdner Kleinwort Wasserstein and Cre´dit Agricole Asset Management in Frankfurt where he was responsible for the fund-of-hedge-funds Marketing Support. He has written several articles on the subject of alternative investments that have been published in professional as well as academic journals. He is the co-author and co-editor of five books on alternative investments published by John Wiley & Sons, Risk Books and Gabler. He holds a Diploma in Business Administration and a Master of Arts in Banking & Finance from the HfB Business School of Finance and Management in Frankfurt, where he has also lectured on alternative investments since 2003. Zeno Adams is Research Assistant at the Department of Empirical Research and Econometrics, University of Freiburg, Platz der Alten Synagoge, D-79085 Freiburg im Breisgau, Germany.
Practical applications The Value at Risk (VaR) approach is widely used within the asset and risk management of traditional and alternative investments. From the investor’s point of view, an adequate VaR model should indicate how the positions of the hedge fund portfolio should be sized for the best protection against downside risk. Due to the skewness and excess kurtosis of daily financial return distributions, the normal VaR has its drawbacks particularly when it is applied to hedge funds. In addition to the Cornish–Fischer VaR, which explicitly accounts for non-normally distributed returns, we examine the conditional volatility characteristics of daily hedge fund management style returns. The inclusion of time-varying conditional volatility into the VaR measurement enables us to trace the actual return process more effectively. We show that such a GARCH-type VaR is a superior measure of downside risk, especially for trading strategies that exhibit negative skewness and excess kurtosis and offer daily pricing.
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Journal of Derivatives & Hedge Funds Volume 13 Number 1 2007 www.palgrave-journals.com/dutr
Journal of Derivatives & Hedge Funds, Vol. 13 No. 1, 2007, pp. 2–25 r 2007 Palgrave Macmillan Ltd 1753-9641 $30.00
Abstract This paper examines the conditional volatility characteristics of daily management style returns and compares the out-of-sample forecasts of different Value at Risk (VaR) approaches, namely, the normal, Cornish–F
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