Liquidity Risk and Mutual Fund Performance
CUNY Baruch College
Boston College - Carroll School of Management
December 6, 2014
AEA 2012 Chicago Meetings Paper
The liquidity risk exposure of mutual funds represents their propensity for taking risk, but can also signify skill, if skillful managers' ability to outperform increases with market liquidity. Consistently, we document an annual liquidity-beta performance spread of 3.3% to 4% in the cross-section of mutual funds. Only a small portion of this spread is explained by risk premia. Instead, a large part is driven by the ability of high-liquidity-beta funds to outperform, either through holding underpriced assets or making informed trades, during periods of improved market liquidity. The findings highlight the multiple effects of liquidity risk on active asset management.
Number of Pages in PDF File: 68
Keywords: Liquidity Risk, Mispricing, Informed Trading, Mutual Fund
JEL Classification: G12, G14, G20, G23
Date posted: March 15, 2011 ; Last revised: December 7, 2014
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