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RFS Advance Access originally published online on December 24, 2008
Review of Financial Studies 2009 22(7):2495-2530; doi:10.1093/rfs/hhn113
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org

Are "Market Neutral" Hedge Funds Really Market Neutral?

Andrew J. Patton
University of Oxford

Send correspondence to Andrew J. Patton, Department of Economics, University of Oxford, Manor Road, Oxford OX1 3UQ, UK; telephone: +44-(0)1865-281-296; E-mail: andrew.patton{at}economics.ox.ac.uk.

JEL Classification: G11, G23


  Abstract

Using a variety of different definitions of "neutrality," this study presents significant evidence against the neutrality to market risk of hedge funds in a range of style categories. I generalize standard definitions of "market neutrality," and propose five different neutrality concepts. I suggest statistical tests for each neutrality concept, and apply these tests to a database of monthly returns on 1423 hedge funds from five style categories. For the "market neutral" style, approximately one-quarter of the funds exhibit significant exposure to market risk; this proportion is statistically significantly different from zero, but less than the proportion of significant exposures for other hedge fund styles.

Helpful comments and suggestions were received from the Editor, Joel Hasbrouck, an anonymous referee, and Vikas Agarwal, Carol Alexander, Ron Anderson, Andrew Ang, Giovanni Belossi, Greg Connor, Jason Hathorn, Aino Levonmaa, Oliver Linton, Andrew Lo, Sophocles Mavroeidis, Narayan Naik, Burt Porter, Joshua Rosenberg, Chester Spatt, Bas Werker, Elliot Williams, and seminar participants at the 2004 European Finance Association meeting, Inquire UK, Aarhus School of Business, University of Amsterdam, Bank of England, LSE, NYU Stern School of Business, and Tilberg University. I would like to thank IAM for providing the data used in this study, and for support through the IAM Programme in Hedge Fund Research at the London School of Economics.


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