Directional and Non-Directional Risk Exposures in Hedge Fund Returns
This paper re-examines the ability of the factor model approach to evaluate the performance of the Equity Hedge, Event Driven, Macro, Relative Value, and Funds of Hedge Funds styles. As Hedge Fund returns are not normally distributed, we assign a premium to higher-order comoments of Hedge Fund returns with the US market aggregate. In addition to traditional asset- (conditioned by the levels of some information variables) and option-based factors, our analysis incorporates two sets of distributional premiums that have not yet been exploited in Hedge Fund asset pricing. We show that US higher-moment equity risk premiums constructed through hedge portfolios on covariance, coskewness, and cokurtosis risks are significant for Equity Hedge, Event Driven, and Macro Hedge Fund styles. Furthermore, we provide evidence that there is still much information embedded in option prices, particularly in the implied higher-moments of Bakshi et al. (2003). These premiums increase the explanatory power of the models across all the Hedge Fund strategies but the Macro and Relative Value categories.