Systemic Risk, Hedge Funds and Modelling Asymmetric Dependence using a Copula Approach

Modelling the dependence structure between asset returns is the cornerstone for portfolio allocation decisions. The central aim of this project is to address the issue of asymmetric dependence of hedge funds and to concentrate on the potential impacts on hedge fund portfolio construction. This is becoming increasingly important, as many mutual funds have increased their exposure to hedge funds. We propose a new method for modelling the nonlinearity of hedge fund exposure to various market risks and concentrate on this method's potential impact on optimal hedge fund portfolio construction. Since, hedge funds have played a major role in the financial crisis we also examine whether hedge funds pose a significant systemic risk for Australia.