Investment risk management is a core capability of all hedge funds that deliver on their capital preservation commitment to investors. The crisis of 2008 demonstrated that expertise in managing investment risk is not enough: minimum competency in the areas of funding, counterparty, and operational risk management are also essential. These risk management capabilities should be developed and integrated into a cohesive framework customized to take account of the primary risks of a given hedge fund.
1. A short time series will potentially result in a VaR based on a fat-tailed distribution.
2. Conditional VaR is performed by assessing the likelihood (at a specific confidence level) that a specific loss will exceed the value at risk. Mathematically speaking, CVaR is derived by taking a weighted average between the value at risk and losses exceeding the value at risk. The size of losses exceeding the value at risk is often based on stress and scenario tests. Note the problem with relying solely on the VaR model is that the scope of risk assessed is limited, since the tail end of the distribution of loss is not typically assessed. Therefore, if losses are incurred, the amount of the losses will be substantial in value.
3. Alvarez, Miguel, and Michael Levinson 2006. Hedge Fund Risk Modeling, MSCI Barra.
4. This technique is used frequently because its implementation is straightforward and it is easy to understand. However, a critical assumption necessary to obtain robust ...