Modelling the Tail Risk in Private Equities and Hedge Funds

Abstract

Monthly return distributions of many private equity and hedge funds indices exhibit a set of distinctive statistical properties; such as skewness, fat-tails, and first-order serial correlation; and if these are ignored then the calculation of risk-return performance measures, asset allocation or loss probabilities of portfolios containing such instruments, will be seriously compromised. The aim of this paper is to provide an insight the time-varying tail of the distribution of private equity and hedge fund indices, while taking into account the statistical challenges posed by such asset classes; namely heterogeneity, risk preferences, non-linearities, and significant serial correlation. The results presented have significant implications for risk management, asset managements and investors’ perceptions.