Essays on sovereign credit risk, long-run risk, and hedge funds

Abstract

This thesis consists of three essays. The first essay studies, using daily CDS spreads, the nature in which the sovereign credit risks of emerging economies are interlinked. By estimating a variant of the multivariate VECM-EGARCH model, it is found that the creditworthiness of nations is well reflected in the direction of Granger causality and volatility transmission, and also in the extent of volatility persistence. In addition, the sovereign CDSs seem to provide a better forum for international diversification of credit risk exposure than do the underlying sovereign bonds. The second essay presents a wavelet-based framework characterizing systematic risk of an asset in terms of the asset’s short-run, intermediate-run, and long-run exposures towards model factors. Taking the Fama-French model as a test bed, it is found that loadings on the long-run components of SMB and HML account better for the cross section of average (monthly) returns than loadings on the short-run or intermediate-run components of the factors. Consistent with the risk-based interpretation of SMB and HML, the long-run components of SMB and HML are better proxies for the ICAPM-based risk factors than the other frequency components of the factors. The third essay re-examines, at a range of investment horizons, the asymmetric dependence between hedge funds and market returns. Given the current availability of hedge fund data, the joint distribution of longer-horizon returns is extracted from the dynamics of monthly returns using the filtered historical simulation; then the method based on copula theory is applied to uncover the dependence structure therein. While the direction of asymmetry remains unchanged, the magnitude of asymmetry is attenuated considerably as the investment horizon increases. Similar horizon effects also occur on the tail dependence. The findings suggest that nonlinearity in hedge fund exposure to market risk is more short-term in nature, and that hedge funds ...