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Derivatives Use and Risk Taking: Evidence from the Hedge Fund Industry

Published online by Cambridge University Press:  19 April 2011

Yong Chen
Yong Chen*
Affiliation:
Pamplin College of Business, Virginia Tech, 1016 Pamplin Hall, Blacksburg, VA 24061, [email protected]
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Abstract

This paper examines the use of derivatives and its relation with risk taking in the hedge fund industry. In a large sample of hedge funds, 71% of the funds trade derivatives. After controlling for fund strategies and characteristics, derivatives users on average exhibit lower fund risks (e.g., market risk, downside risk, and event risk), such risk reduction is especially pronounced for directional-style funds. Further, derivatives users engage less in risk shifting and are less likely to liquidate in a poor market state. However, the flow-performance relation suggests that investors do not differentiate derivatives users when making investing decisions.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 4 , August 2011 , pp. 1073 - 1106
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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