Equity market neutral hedge funds and the stock market: an application of score-driven copula models

ABSTRACT

In this article, we study the time-varying market neutrality of equity market neutral hedge funds. We use data from the Hedge Fund Research™ Equity Market Neutral Index (HFRX EH), which represents the performance of a portfolio of individual equity market neutral hedge funds. For each day, we measure different levels of association of the Standard and Poor’s 500 (S&P 500) index and the HFRX EH. We use non-linear dynamic conditional score models of location, scale and copula that, to the best of our knowledge, have not yet been applied in the body of literature on hedge funds. We study whether the neutrality of the HFRX EH that is evidenced in the body of literature for the period of April 1993–April 2003 also holds for the following decade, for the period of May 2003–December 2016. We estimate different average levels of association for the pre-, during- and post-periods of the US financial crisis of 2008. We find that the association of the S&P 500 and the HFRX EH, on average, is significantly positive for the pre- and post-periods of the financial crisis, and it is significantly negative for the period during the financial crisis.

KEYWORDS:

• Equity market neutral hedge funds
• dynamic conditional score (DCS) models
• Gen-t-QAR
• Beta-Gen-t-EGARCH with leverage effects
• DCS model with Student’s t copula

JEL CLASSIFICATION:

• C22
• C52

Acknowledgements

The authors are thankful for the helpful comments of the anonymous reviewer and Matthew Copley.

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by the Universidad Francisco Marroquín.