RISK SPILLOVER AMONG HEDGE FUNDS: THE ROLE OF REDEMPTIONS AND FUND FAILURES – Klaus and Rzepkowski (2009) Discussed by Jingjing Xia

Brief Summary  Analyze mortality patterns of hedge funds and identify risk spillover  Use individual fund data from TASS ( )  Two channels: “bank” run; counterparty risk  Apply binary logit model and semiparametric Cox (robustness check)  1) There is significant risk spillover between funds on failure probability; 2) Funds within the same investment style affected by both channels; 3) Funds across different investment style affected by redemption only; 4) Diversification reduces failure probability significantly.  Contribution: few literatures; individual fund data

C1: Contagion?  The model estimate correlation between failures of different hedge funds not unobserved factors that cause failure of one fund conditional the failure of others

C2: Data?  Possible sampling bias: Before filter Alive and 5000 Graveyard; After filter – 2600 Alive and 2600 Graveyard.  The total AUM of sample hedge funds is about 0.5 trillion USD (1/4)  Is the sample representative?  The time period of data goes from 1994 to Maybe better includes data after 2008 for contagion analysis (not authors’ fault)

C3: Model?  Latent failure probability ?  Endogeneity issue? Yearly dummy is used to capture the impact of common shocks? FIXED EFFECT IS FOR UNOBSERVABLE FACTORS!  Redemption variable: better be dummy than ratio

C4: Diversification  How diversification is defined? Geographic diversification and assets diversification. BUT  No idea about investment values! 1% in India + 99% in US = diversified!  May introduce other effects: geographic diversification – emerging market focus funds (may diversify across emerging countries); asset diversification – fixed income focus fund (may diversify across maturities and even countries)