Hedge funds and the impact of diversification and higher moment risks

Hedge funds have attracted considerable interest from institutional investors including public pension funds and college endowments in recent years. The first two essays in this thesis aim to provide a better understanding of the (often hidden) risks and reward associated with hedge fund investments.

In the first essay I examine the relationship between the degree of a hedge fund's factor risk concentration and its performance. Specifically, I examine a hedge fund's level of diversification by estimating the Euclidean distance between a vector of factor exposures from a constrained regression and an equal-weighted vector of a hypothetically balanced fund.

A larger distance measure indicates a fund with more concentrated factor risk exposure. I find that volatility, expected shortfall, tail risk beta, idiosyncratic risk, and risk of failure increase, while fund alpha declines in magnitude as Euclidean distance increases.

In the second essay, I find that zero-R2 funds sorted into the most extreme quintile of tail risk exposure have higher than expected levels of systemic risk. Further, high levels of tail risk exposure are a significant determinant of the zero-R2 status of hedge funds and lead to higher risk of failure.

In the third essay, using price levels from the Iowa Electronic Markets, evidence suggests that partisanship has a negative impact on the congressional election prospects of the party initiating the partisan fight. In contrast, bipartisan accomplishments increase the congressional election prospects of party initiating the efforts that become bipartisan.