Are "Market Neutral" Hedge Funds Really Market Neutral?

Using a variety of different definitions of "neutrality," this study presents significant evidence against the neutrality to market risk of hedge funds in a range of style categories. I generalize standard definitions of "market neutrality," and propose five different neutrality concepts. I suggest statistical tests for each neutrality concept, and apply these tests to a database of monthly returns on 1423 hedge funds from five style categories. For the "market neutral" style, approximately one-quarter of the funds exhibit significant exposure to market risk; this proportion is statistically significantly different from zero, but less than the proportion of significant exposures for other hedge fund styles. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org, Oxford University Press.