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The Market Timing Skills of Hedge Funds during the Financial Crisis
Cavé, Arnaud; Hübner, Georges; Sougné, Danielle
2011Atelier thématique sur les Hedge Funds
 

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Keywords :
Performance measurement; Hedge Fund performance; option replication
Abstract :
[en] Purpose -- The purpose of this paper is to gain a better understanding of the market timing skills displayed by hedge fund managers during the 2007-08 financial crisis. Design/methodology/approach -- The performance of a market timer can be measured through the Treynor and Mazuy (1966) model, provided the regression alpha is properly adjusted by using the cost of an option-based replicating portfolio, as shown by Hübner (2010). We adapt this approach to the case of multi-factor models with positive, negative or neutral betas. This new approach is applied on a sample of hedge funds whose managers are likely to exhibit market timing skills. We stick to funds that post weekly returns, and analyze three hedge funds strategies in particular: long-short equity, managed futures, and funds of hedge funds. We analyze a particular period during which the managers of these funds are likely to magnify their presumed skills, namely around the financial and banking crisis of 2008. Findings -- Some funds adopt a positive convexity as a response to the US market index, while others have a concave sensitivity to the returns of an emerging market index. Thus, we identify "positive", "mixed" and "negative" market timers. A number of signs indicate that only positive market timers manage to acquire options below their cost, and deliver economic significant performance, even in the midst of the financial crisis. Negative market timers, by contrast, behave as if they were forced to sell options without getting the associated premium. We interpret this behavior as a possible result of fire sales, leading them to liquidate positions under the pressure of redemption orders, and inducing negative performance adjusted for market timing. Research limitations/implications -- The adjustment for market timing opens up the way to numerous tests over longer periods, and in particular comparative studies of hedge fund returns using nonlinear risk factors versus exposures to quadratic returns. Originality/value -- The paper suggests that the convexity in returns that is generally associated with market timing can be attributed to three sources: timing skills, exposure to nonlinear risk factors, or liquidity pressures. We manage to identify the impact of the latter two effects in the context of hedge funds.
Disciplines :
Finance
Author, co-author :
Cavé, Arnaud
Hübner, Georges  ;  Université de Liège - ULiège > HEC-Ecole de gestion : UER > Gestion financière
Sougné, Danielle ;  Université de Liège - ULiège > HEC-Ecole de gestion : UER > Gestion financière et consolidation
Language :
English
Title :
The Market Timing Skills of Hedge Funds during the Financial Crisis
Publication date :
22 March 2011
Event name :
Atelier thématique sur les Hedge Funds
Event organizer :
Laboratoire d'Economie d'Orléans
Event place :
Orléans, France
Event date :
22 mars 2011
By request :
Yes
Audience :
International
Available on ORBi :
since 29 April 2012

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