Abstract
We decompose hedge fund tail risk into two components: Systematic Conditional Tail Risk (SCTR) arising predictably from equity market exposure, and Idiosyncratic Conditional Tail Risk (ICTR) arising from proprietary investment technology. Using option holdings data, we demonstrate that low-SCTR funds mechanically use protective options. Low-ICTR funds seem to pose tail risk hedging skills, because they use protective options heavily only during the times of market stress. Low-ICTR (Low-SCTR) funds (do not) deliver superior performance. Our results hold after controlling for performance measure manipulation, nonlinearities and autocorrelation in fund returns, and cannot be subsumed by existing skill or risk measures.
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