Dynamic Exposure of Hedge Funds to the Changes in the Risk Factors

This paper models exposure of hedge fund to risk factors and examines time-varying performance of hedge funds. From existing models such as ABS-factor model, SAC-factor model, and four-factor model, we extract the best six factors for each hedge fund portfolio by investment strategy. Then, we find combinations of risk factors that most explain variance in performance of each hedge fund portfolio by investment strategy. The results show instability of coefficients in the performance attribution regression. Incorporating time-varying factor exposure feature would be the best way to appropriately measure hedge fund performance. Furthermore, the optimal models with fewer factors exhibit greater explanatory power than existing models. Time-varying model customized by investment strategy of hedge funds would clearly show how sensitive to risk factors managements of hedge funds are according to market conditions