Hedge Fund Strategies

Market neutral

Index:

1. Definitions2. Correlation neutrality3. Mean neutrality4. Variance neutrality5. Value-at-risk neutrality6. Tail neutrality7. Complete neutrality8. Are market-neutral hedge funds really market neutral?

Market neutral

Market neutrality:

“Depth”: reproduces the completeness of the neutrality of the fund to market risks;

“breadth”: reveals the number of market risks to which the hedge fund is neutral.

(Patton, 2004)

1. Definitions

Correlation neutrality:

An investor facing returns that are multivariate normally distributed or one with quadratic utility, will only require linear correlation as the measure of dependence.

(Patton, 2008)

2. Correlation neutrality

Mean neutrality:

Is the expected return on the fund being independent of the return on the market. Requires not only that there are no nonlinear relationships, but also that there is no linear relationship between the market return and the fund return.

(Patton, 2008)

3. Mean neutrality

Variance neutrality:

Considering risk as measured by variance, while not constant, is expected that the risk of the fund does not increase at the same time as the risk of the market index. That means the risk of the fund is neutral to market risk.

(Patton, 2008)

4. Variance neutrality

Value-at-risk neutrality:

Given that the VaR of a fund is simply a quantile of its distribution of returns, value-at-risk neutrality implies that all quantiles of the fund are neutral to the market.

(Patton, 2008)

5. Value-at-risk neutrality

Tail neutrality:

Implies that conditioning on the fact that an extremely low return on the market is observed do not affect the probability of an extremely low return on the fund.

(Patton, 2008)

6. Tail neutrality

Complete neutrality:

Requires completely indenpence on the market return by the distribution of fund returns.

(Patton, 2008)

7. Complete neutrality

Patton, A. J., 2004, ‘Are “Market Neutral” Hedge Funds Really Market Neutral?’ London School of Economics

Patton, A. J., 2008, ‘Are “Market Neutral” Hedge Funds Really Market Neutral?’ Oxford University Press

References