The Evolving Beta-Liquidity Relationship of Hedge Funds
VU University Amsterdam
Universite du Luxembourg - School of Finance
September 17, 2014
Using an optimal changepoint approach, we find a structural change in the relation between hedge funds’ stock market exposure and aggregate stock market liquidity that takes place in the period 2000 to 2002. Before the structural break, market betas have no relation to liquidity and only a few style categories of hedge funds show increased market presence when liquidity is low. After the break, the relationship is inverted, pointing towards an increased liquidity timing ability of hedge funds, as users of liquidity. We relate our findings to best execution rules and decimalization in the US stock market that were introduced in that period and impacted aggregate liquidity conditions. Furthermore, the returns to a momentum strategy display a similar structural break and momentum-loading funds constitute a sizeable proportion of hedge funds that manifest a distinct beta-liquidity evolution with a structural break in that period.
Number of Pages in PDF File: 42
Keywords: market timing, hedge funds, market liquidity, hedge funds, momentum
JEL Classification: G12, G23
Date posted: March 19, 2012 ; Last revised: September 30, 2014
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