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This paper deciphers tail risk in hedge funds from option-based dynamic trading strategies. It demonstrates multiple and tradable tail risk premia strategies as measured by pricing discrepancies between real-world and risk-neutral distributions are instrumental determinants in hedge fund performance, in both time-series and cross-section. After controlling for Fung-Hsieh factors, a positive one-standard deviation shock to volatility risk premia is associated with a substantial decline in aggregate hedge fund returns of 25.2% annually. The results particularly evidence hedge funds that significantly load on volatility (kurtosis) risk premia subsequently outperform low-beta funds by nearly 11.7% (8.6%) per year. This finding suggests to what extent hedge fund alpha arises actually from selling crash insurance strategies. Hence, this paper paves the way for reverse engineering the performance of sophisticated hedge funds by replicating implied risk premia strategies.
