Risk and Beta Anatomy in the Hedge Fund Industry

The objective of this paper is to inspect the time variation of the systematic risk exposures of the major hedge fund strategies over time. To this end we introduce a Bayesian time-varying beta model imposing a structure on fund returns, betas and benchmark returns. Such a beta decomposition proves to be useful for shedding some light on risk dynamics, fund cloning, performance appraisal and the mechanism through which the risk in hedge fund strategies propagates within the industry as a whole.