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Hedge-Fund Performance and Liquidity Risk

Ronnie Sadka

Boston College - Carroll School of Management

April 27, 2011

This paper demonstrates that liquidity risk as measured by the covariation of fund returns with unexpected changes in aggregate liquidity is an important predictor of hedge-fund performance. The results show that funds that significantly load on liquidity risk subsequently outperform low-loading funds by about 6.5% annually, on average, over the period 1994-2009, while negative performance is observed during liquidity crises. The returns are independent of share restriction, pointing to a possible imbalance between the liquidity a fund offers its investors and the liquidity of its underlying positions. Liquidity risk seems to account for a substantial part of hedge-fund performance. The results suggest several practical implications for risk management and manager selection.

Number of Pages in PDF File: 18

Keywords: hedge funds, liquidity risk, share restriction, manager selection, risk management

JEL Classification: G12, G14, G23

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Date posted: August 27, 2011  

Suggested Citation

Sadka, Ronnie, Hedge-Fund Performance and Liquidity Risk (April 27, 2011). Available at SSRN: http://ssrn.com/abstract=1917118 or http://dx.doi.org/10.2139/ssrn.1917118

Contact Information

Ronnie Sadka (Contact Author)
Boston College - Carroll School of Management ( email )
140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
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