Abstract
Hedge funds sold the dream to investors of being able to easily hedge risk. However, Long-Term Capital Management (LTCM) and the recent crisis show that this is not the case. The new frontier in this field is the construction of portfolios of hedge funds – so-called funds of hedge funds (FoHFs). The aim is to eliminate risk through diversification. This chapter investigates data on FoHF indexes provided by BarclayHedge and Hedge Fund Research. Our research shows that during this recent crisis, FoHFs present large and fat left-hand tails. Using our decomposition procedure based on a multifactor switching regime model we find that credit risk is by far the most important factor for tail risk of FoHFs during crisis. Other important factors include term spread and momentum.
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