Hedge-Fund Performance and Liquidity Risk
Boston College - Carroll School of Management
June 1, 2012
Journal of Investment Management (JOIM), Second Quarter 2012
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.
Keywords: Hedge funds, liquidity risk, share restriction, manager selection, risk management
JEL Classification: G00Accepted Paper Series
Date posted: June 2, 2012
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