Do Hedge Funds Have Enough Capital? A Value-at-Risk Approach *

Anurag Gupta† Bing Liang‡

April 2004

____________________________________ *We thank Stephen Brown, Sanjiv Das, Will Goetzmann, David Hseih, Kasturi Rangan, Peter Ritchken, Bill Sharpe, Ajai Singh, Jack Treynor, and two anonymous referees for comments and suggestions on earlier drafts, and the seminar participants at Case Western Reserve University, University of Massachusetts at Amherst, Virginia Tech., the 2003 European Finance Association Meetings in Glasgow, the 2003 Western Finance Association Meetings in Los Cabos, the 2003 QGroup fall seminar in Scottsdale, the 2001 FMA European Meetings in Paris, and the 2001 FMA meetings in Toronto. Bing Liang acknowledges a summer research grant from the Weatherhead School of Management, Case Western Reserve University. We also thank TASS Management Limited for providing the data. We remain responsible for all errors. †Department of Banking and Finance, Weatherhead School of Management, Case Western Reserve University, Cleveland, OH 44106. Phone: (216) 368-2938, Fax: (216) 368-6249, E-mail: anurag.gupta@case.edu. ‡Department of Finance and Operations Management, Isenberg School of Management, University of Massachusetts, Amherst, MA 01003. Phone: (413) 545-3180, Fax: (413) 545-3858, E-mail: bliang@som.umass.edu.

Do Hedge Funds Have Enough Capital? A Value-at-Risk Approach

Abstract
We examine the risk characteristics and capital adequacy of hedge funds through the Value-at-Risk approach. Using extensive data on nearly fifteen hundred hedge funds, we find that only 3.7% live and 10.9% dead funds are under-capitalized as of March 2003. Moreover, the undercapitalized funds are relatively small and constitute a tiny fraction of the total fund assets in our sample. Cross-sectionally, the variability in fund capitalization is related to size, investment