Hedge Fund Risk Fundamentals: Solving the Risk Management and Transparency Challenge

CHAPTER 6

Understanding the Source of Risk

A variety of approaches are used by the traditional buy-side to quantify and explain the source of risk:

• “Slicing and dicing” or “bucketing”
• Index-based benchmarks
• Value at Risk (VaR)
• Risk-factor framework

The first three do not represent statistically significant tools to understand the risks inherent in hedge funds. However, the fourth tool, a risk-factor framework, can simultaneously provide both a holistic approach to measuring risk and a fundamental understanding of the source of risk. Furthermore, as is discussed in later chapters, such an approach provides an additive framework that can permit risk transparency on a structural level without requiring the disclosure of specific holdings.

Slicing ...