Can Liquidity Risk Explain the Size-Performance Relationship for Hedge Funds?
Hany A. Shawky
State University of New York at Albany - School of Business and Center for Institutional Investment Management
State University of New York at Albany - School of Business
March 1, 2011
Using data from the Lipper/TASS hedge fund database over the period 1994-2008, we examine the role of liquidity risk in explaining the relationship between asset size and hedge fund performance. While a significant negative size-performance relationship is documented for all hedge funds, once liquidity risk is accounted for, this relationship only exists among funds in the highest liquidity risk quintile. This result cannot be fully explained by the liquidity hypothesis. Liquidity risk is found to be another important source of diseconomies of scale in the hedge fund industry. Evidently, for high liquidity risk funds, large funds are less able to recover from the more significant losses incurred during market-wide liquidity crises, resulting in lower performance for large funds relative to small funds.
Number of Pages in PDF File: 47
Keywords: Liquidity Risk, Hedge Funds, Asset Size, Performance, Diseconomies of Scales
JEL Classification: G12, G14, G23working papers series
Date posted: September 30, 2010 ; Last revised: May 6, 2012
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