Dedicated Short Bias Hedge Funds: Diversification and Alpha during Financial Crises

Abstract

During the recent financial crisis dedicated short bias (DSB) hedge funds exhibited extremely strong results while many other hedge fund strategies suffered badly. This article, prompted by this recent episode, investigates DSB hedge fund performance over an extended sample period, from January 1994 to December 2008. Performance and risk evaluation are carried out on an equally weighted DSB hedge fund portfolio using three different factor model specifications and both linear and nonlinear estimation techniques. The authors conclude that DSB hedge funds are a significant source of diversification for equity market investors and produce statistically significant levels of alpha. Their findings are robust to the specification of traditional and alternative risk factors, nonlinearity, and the omission of the crisis periods, which are particularly favorable for the DSB strategy.

TOPICS: Real assets/alternative investments/private equity, options, financial crises and financial market history, statistical methods