A study of the impact of different risk factors on the performance and default probability of hedge funds : the case of the 2007-2008 and COVID-19 financial crises

Abstract

By using a sample of more than 500 hedge funds’ monthly data for the period 2000 – May 2020, this thesis investigates the effect of several risk factors on the performance of the hedge funds’ two investment styles of equity and fixed income during the 2007-2008 financial crisis and Covid19 crisis, the periods preceding both crises as well as the period after the 2007-2008 crisis. The impact that different factors and hedge funds’ characteristics have on the default probability consequent to both crises is also studied. The analysis of the different risk factors provides with unexpected results for different risk factors, such as the statistical insignificance of the S&P (Standard & Poor’s) 500 market factor for equity funds during the pre-2007-2008 crisis due to its large variation. A big variation is also found with regard to the spread between corporate and treasury bonds. The study of liquidity risk suggests how funds load more on this type of risk and hold more illiquid assets before the two crises. On the other hand, funds decrease their exposure to illiquidity and their illiquid holdings both during the 2007-2008 crisis and the period after it. While an increase in funds’ performance, Assets Under Management (AUM) and leverage results in a decrease in funds’ liquidation probability during the 2007-2008 crisis, an increase in fund flow and performance fees might lead funds to increase the amount of risk taken and to a consequential rise in the default probability.