Liquidity Risk and the Cross-Section of Hedge-Fund Returns
Boston College - Carroll School of Management
September 29, 2009
Journal of Financial Economics (JFE), Forthcoming
This paper demonstrates that liquidity risk as measured by the covariation of fund returns with unexpected changes in aggregate liquidity is an important determinant in the cross-section of hedge-fund returns. The results show that funds that significantly load on liquidity risk subsequently outperform low-loading funds by about 6% annually, on average, over the period 1994-2008, while negative performance is observed during periods of significant liquidity crises. The returns are independent of the liquidity a fund provides to its investors as measured by lockup and redemption notice periods, and are also robust to commonly used hedge-fund factors, none of which carries a significant premium during the sample period. These findings highlight the importance of understanding systematic liquidity variations in the evaluation of hedge-fund performance.
Number of Pages in PDF File: 36
Keywords: Liquidity risk, Hedge funds, Price impact, Asset pricing
JEL Classification: G12, G14Accepted Paper Series
Date posted: March 22, 2009 ; Last revised: November 12, 2009
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