Return or position-based value at risk?

Abstract

The emergence of managed account platforms for investing in hedge funds has given the investor access to a range of new risk measures. This study analyses the accuracy of various value at risk (VaR) methodologies in the context of hedge fund investing. In our sample of data, we found that position-based VaR provides the best risk assessment measure for short horizons (up to five days). For longer term horizons (five days or more), position-based VaR can sometimes be inaccurate. Our interpretation is that, despite being based on actual underlying positions, position-based VaR is not designed to capture the dynamic of hedge fund portfolios. Over longer term horizons, VaR calculated using historic returns still provides a rough but reliable risk indicator for the investor. Our study also highlights the importance of regular monitoring of any risk model’s accuracy in its specific context.