ABC Quant Blog: Views on Risk Management

The Modified Value-at-Risk (MVaR) uses the Cornish–Fisher asymptotic expansion to adjust the normal VaR by incorporating skewness and kurtosis, providing a more accurate estimate of tail risk for non-normal return distributions.

The Conditional Value-at-Risk (CVaR) is defined as the expected value of the losses assuming that the losses exceed the VaR. Learn relation between the VaR and the CVaR, its proc and cons for risk assessment.

Biases in fund databases present another serious problem originated from the following reasons. First, databases include only a part of the whole hedge find population that varies from 30 percent to 50 percent. Second, some biases are derived from the peculiar terms of counting hedge funds and their respective returns.

The hardest aspect about hedge fund properties is to understand that they present an entirely distinct category of financial instruments, therefore, deploying a traditional methodology commonly used for stocks and bonds, will lead to the unexpected and most questionable results.

Typical mistakes in hedge fund valuation and risk assessment arise from neglecting their unique properties: non-normal return distributions, low transparency, bizzarre hedge fund indices, inapplicability of the mean-variance methodology, numerous data biases etc. The distinct hedge fund valuation and risk management problems can be outlined as follows...

The Markowitz’s mean-variance methodology is hardly applicable for hedge fund risk assessment. Since its introduction, the mean-variance methodology became the primary tool for portfolio diversification used by the majority of pension and mutual funds globally. However, despite its popularity, the mean-variance approach suffers important drawbacks...

Based on the Markowitz’s mean-variance model, the Capital Asset Pricing Model (CAPM) inherits all the shortcomings of the latter in addition to its own assumptions that makes it hardly applicable for hedge funds and non-linear assets. While the CAPM still emerges as the most commonly used approach for both institutional and private investors, using it for hedge funds could be disastrous.

Introduced in 2002 by Keating and Shadwick, Omega ratio is a relatively new addition in a hedge fund metrics library. By employing higher moments and taking into account actual shapes of distributions of returns, this measure is well-suited for hedge fund risk assessment, because of non-normality of their distributions.