Liquidity Risk and Mutual Fund Performance
CUNY Baruch College
Boston College - Carroll School of Management
July 9, 2014
AEA 2012 Chicago Meetings Paper
This paper hypothesizes that market liquidity constrains mutual fund managers' ability to outperform, which introduces a higher liquidity risk exposure (beta) for skilled managers. Consistently, we document an annual liquidity beta performance spread of 4% in the cross-section of mutual funds over the period 1983-2014. Liquidity risk premia based on traditional passive equity portfolios can explain only an insubstantial part of this spread. Instead, the differential ability of high liquidity beta funds to outperform across high and low market liquidity states, whether due to differential rate of mispricing correction or intensity of informed trading, contributes significantly to explaining this spread. The findings highlight the complex effect of liquidity risk on active management.
Number of Pages in PDF File: 55
Keywords: Liquidity risk, Finanical institutions, Price impact, Asset pricing
JEL Classification: G12, G14
Date posted: March 15, 2011 ; Last revised: October 20, 2015
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