Do Hedge and Merger Arbitrage Funds Actually Hedge? A Time-Varying Volatility Spillover Approach

What is it about?

-We examine the connectedness among hedge replication, merger arbitrage funds and a set of major traditional assets. -We employ the TVP-VAR approach of Antonakakis et al. (2020). -We find moderate volatility spillovers, which escalated during periods of turmoil. -Hedge replication and merger arbitrage funds demonstrate a more neutral behavior in comparison to other net receivers like commodities, bonds and real estate. - The short position in the volatility of the funds proves to be an excellent hedging tool for all asset classes, with the exception of currency.

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Why is it important?

We examine the interaction between funds implementing hedge and merger arbitrage strategies and a set of traditional assets comprising equities, bonds, gold, crude oil, currency, commodities and real estate, by applying a time-varying spillover approach for the period 1/1/2010-7/31/2020. Results indicate that the funds absorb the fewest shocks from equities, crude oil, gold and currency compared to commodities, bonds and real estate. Furthermore, we test the effective hedging ability of these funds by estimating hedge ratios and optimal portfolio weights. Taking a short position in the volatility of the funds provides impeccable hedging effectiveness for all asset classes, except currency.

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