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Why do Hedge Funds’ worst returns cluster? Common shocks vs. contagion by Nicole Boyson, Christof Shahel and Rene Stulz

Why do Hedge Funds’ worst returns cluster? Common shocks vs. contagion by Nicole Boyson, Christof Shahel and Rene Stulz. Discussion by Robert Kosowski (Director, Centre for Hedge Fund Research) Imperial College Business School, Imperial College London. Discussion Outline.

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Why do Hedge Funds’ worst returns cluster? Common shocks vs. contagion by Nicole Boyson, Christof Shahel and Rene Stulz

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  1. Why do Hedge Funds’ worst returns cluster? Common shocks vs. contagionby Nicole Boyson, Christof Shahel and Rene Stulz Discussion by Robert Kosowski (Director, Centre for Hedge Fund Research) Imperial College Business School, Imperial College London

  2. Discussion Outline • Very nice paper and comprehensive analysis! • Main Findings • Methodology and Data • Related Literature • Extensions and Suggestions • Policy Implications • Conclusions

  3. Main Findings • Do HF drawdowns cluster? If so, why? • Do liquidity shocks predict drawdowns? Contagion vs Exogenous Shock Liquidity Channel ? Fund Channel • Policy Maker: Do drawdowns predict liquidity shocks? ?

  4. Methodology and Data • Logistic Regression, GARCH filter • Data • Comprehensive liquidity proxies (PB,...) • what about on-the-run/off-the run Garcia and Fontaine (2008), Goyenko and Sarkissian (2008))? • HFR indices versus individual funds • Monthly versus daily returns • Total or risk-adjusted return (α+Ɛ ) contagion?

  5. Related Literature • Chan, Getmansky, Haas, and Lo (2005) • Khandani and Lo (2007) • Billio, Getmansky and Pelizzon (2007): daily returns • Buraschi, Kosowski and Trojani (AFA, 2010) • ‘When there is No Place to Hide - Correlation Risk and the cross-section of hedge fund returns ’ • Correlation Swap= RC-IC • Correlation Risk Priced in Cross-section of Hedge Fund Returns

  6. Comments and Suggestions • T1 (Macro and RV Count less sign’t; Merger Arb, EMktN, DS sign’t) vs Fig3 • Many liquidity proxies and fund strategies • More detail on mechanism, e.g. • Repo and Merger arb? Repo and RV ! • CSS and DS? CSS and EMktN ! • T4: Economic Interpretation • S&P vol not significant for ConvArb • Economic relevance? • Fund Liquidations (Chan et al (2005)) • Drawdown at t-1 and liquidity proxy at t

  7. Figure 5/Table VI (Liquidity Proxy at t-1 and Drawdown at t):

  8. Policy Implications • Do hedge fund drawdowns predict (cause?) liquidity dry-ups/losses in other sectors? • P.26: unreported results (aggregate liquidity proxy as dependent variable) • ‘...a high number of worst returns for hedge fund styles makes it more likely that there will be a high adverse liquidity shock...’ • Which strategies? • Leverage limits? Short-sale restrictions? Disclosure requirements? • Healy and Lo (2008) ‘Jumping the Gates: Using Beta-Overlay Strategies to Hedge Liquidity Constraints’

  9. Conclusions • Very nice paper • Evidence of hedge fund clustering • Liquidity proxies predict hedge fund clustering • Potential to elaborate on policy implications • Interpret evidence by HF category

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