“Derivatives Use and Risk Taking: Evidence from the Hedge Fund Industry” by Yong CHEN
The use of derivatives by hedge funds is consistent with hedging as opposed to speculation. From a large sample of hedge funds, approximately three-fourths of the funds trade derivatives, over three times as large as that of mutual funds. Derivatives tend to be used by funds that charge higher incentive fees, impose a less restrictive redemption policy, have management ownership, and employ effective auditing. Derivatives users exhibit lower risk than nonusers: annual return volatility of derivatives users is 1.2 percentage points lower than that of nonusers; risk reduction is more pronounced for systematic risk and extreme event risk; and derivatives users engage less in risk gaming.