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Value at Risk, GARCH Modelling and the Forecasting of Hedge Fund Return Volatility

Roland Füss, Dieter K. Kaiser & Zeno Adams

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abstract This paper examines the conditional volatility characteristics of daily management style returns and compares the out-of-sample forecasts of different Value at Risk (VaR) approaches, namely, the normal, Cornish–Fisher (CF), and the so-called GARCH-type VaR. The examination of the conditional volatility of hedge fund styles and composite returns shows important differences concerning persistence, mean reversion and asymmetry in the period under consideration. Hedge fund returns exhibit significant negative skewness and excess kurtosis, which cannot be captured in the normal VaR whereas the CF-VaR results in a systematic downward shift of the conventional VaR. The GARCH-type VaR, however, includes the time-varying conditional volatility and is able to trace the actual return process more effectively. Since the forecast performance cannot detect which of the three VaR types can match the time-varying risk adequately, an adjusted hit ratio takes the size of the hits as well as the average VaR into account. According to this, the GARCH-type VaR outperforms the other VaRs for most of the hedge fund style indices.
   
type journal paper
   
keywords hedge funds, Value at Risk, GARCH models, forecasting
   
language English
kind of paper journal article
date of appearance 10-1-2007
journal Journal of Derivatives and Hedge Funds
publisher Palgrave Macmillan
ISSN 1074-1240
volume of journal 13
number of issue 1
page(s) 2-25
review not reviewed
   
citation Füss, R., Kaiser, D. K., & Adams, Z. (2007). Value at Risk, GARCH Modelling and the Forecasting of Hedge Fund Return Volatility. Journal of Derivatives and Hedge Funds, 13(1), 2-25.