The liquidity risk of liquid hedge funds

• Main Author: TEO, Melvyn
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2010
• Subjects: Hedge funds; liquidity risk; funding liquidity; asset-liability mismatch; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/5326; https://ink.library.smu.edu.sg/context/lkcsb_research/article/6325/viewcontent/liquidity_paperXVI.pdf
• Institution: Singapore Management University

This paper evaluates hedge funds that grantfavorable redemption terms to investors. Within this group of purportedlyliquid funds, high net inflow funds subsequently outperform low net inflowfunds by 4.79% per year after adjusting for risk. The return impact of fundflows is stronger when funds embrace liquidity risk, when market liquidity islow, and when funding liquidity, as measured by the Treasury-Eurodollar spread,aggregate hedge fund flows, and prime broker stock returns, is tight. Inkeeping with an agency explanation, funds with strong incentives to raisecapital, low manager option deltas, and no manager capital co-invested are morelikely to take on excessive liquidity risk. These results resonate with thetheory of funding liquidity by Brunnermeier and Pedersen (2009).