Three Essays on Political Risk, Economic Policy Uncertainty, and Hedge Fund Returns

This thesis comprises three empirical essays on political risk, economic policy uncertainty, and hedge fund returns, employing a sample over a period of 1990-2017. The first essay investigates the relation between political risk and hedge fund returns and assesses whether the effects of political risk on hedge fund returns will vary across different hedge fund strategies. The second essay examines the relationship between economic policy uncertainty and hedge fund performance and tests whether the effects of economic policy uncertainty on performance will vary across hedge fund investment strategies. The final essay explores whether hedge fund managers can successfully time economic policy changes at both the aggregate and strategy levels. Using three analytical approaches, namely, univariate portfolio analysis, multivariate portfolio analysis through Fama and MacBeth (1973) regressions, and time series analysis, we document the following findings:

In the first essay, we show that political risk exposure is an important determinant of hedge fund returns. After controlling for fund characteristics, we find a robust and significant negative risk premium for political risk exposure in the cross-section of hedge fund returns. We also discover that the effects of political risk on hedge fund performance do vary with different hedge fund strategies, where political risk is negative and significant for all strategies with the exception of managed futures, event driven, distressed securities, and fixed income strategies. This suggests that political risk can explain the variation in fund returns, thereby being a potential pricing factor in hedge fund performance.

In the second essay, we find that economic policy uncertainty is a highly significant factor explaining the dispersion of cross-sectional hedge fund returns. After controlling for different sets of hedge fund characteristics, economic policy uncertainty remains negative and highly significant. Therefore, economic policy uncertainty is an important determinant of the cross-sectional differences in hedge fund returns. We also show that the effects of economic policy uncertainty on hedge fund returns do vary across different hedge fund strategies, where 11 of the 13 hedge fund strategies exhibit negative and significant economic policy loadings, except for global macro and managed futures funds. Hence, this finding suggests that economic policy uncertainty appears to be a potential pricing factor in hedge fund performance.

In the final essay, we show that hedge fund managers can successfully time fluctuations in economic policy changes at both the aggregate and strategy levels, using pooled panel regressions based on the Henriksson and Merton model. Our results are robust to the use of alternative test method, that is, time series analysis. In addition, we discover that 36.8% of the funds in our sample possess the ability to time economic policy changes. Overall, the results show the existence of hedge funds’ economic policy timing ability at both the aggregate and strategy levels.

This thesis makes important contributions to the literature on determinants of hedge fund returns as well as hedge fund and timing literature and enhance our understanding of how political risk and economic policy uncertainties after hedge fund strategies and performance.