Evaluating and Predicting the Failure Probabilities of Hedge Funds

Hedge funds have the most sophisticated risk management practices; however, hedge funds also appear to have a short lifetime relative to other managed funds. In this study, we investigate the failure probabilities of hedge funds — particularly the failures due to financial distress. We forecast the failure probabilities of hedge funds using both a proportional hazard model and a logistic model. By utilizing a signal detection model and a relative operating characteristic curve as the prediction accuracy metrics, we found that both of the models have predictive power in the out-of-sample test. The proportional hazard model, in particular, has stronger predictive power, on average