The Role of Hedge Funds in International Financial Markets

This paper analyses the risk and return characteristics of a wide universe of hedge funds in the period 1990–2000. Most major categories of hedge funds are found to have outperformed (often by a considerable margin) the performance of traditional asset classes. The potential impact of hedge fund trading on market spreads and volatilities is examined especially in the period 1998, so as to provide some guidelines in terms of regulation of such funds. It is shown, however, that despite hedge fund difficulties in that period, the inclusion of hedge funds in investor portfolios definitely moves the efficiency frontier outwards, and allows significantly higher levels of returns for given levels of risk. This is primarily because of the low level of correlation of certain hedge fund styles, especially arbitrage strategies, with other hedge fund styles and with traditional assets. (J.E.L.: G10, G11, G14, G23).