Hedge Fund Contagion and Liquidity

46 Pages Posted: 9 Jun 2008 Last revised: 11 Jun 2022

See all articles by Nicole M. Boyson

Nicole M. Boyson

Northeastern University - D’Amore-McKim School of Business

Christof W. Stahel

Investment Company Institute

René M. Stulz

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: June 2008

Abstract

Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.

Suggested Citation

Boyson, Nicole M. and Stahel, Christof W. and Stulz, Rene M., Hedge Fund Contagion and Liquidity (June 2008). NBER Working Paper No. w14068, Available at SSRN: https://ssrn.com/abstract=1142240

Nicole M. Boyson

Northeastern University - D’Amore-McKim School of Business ( email )

360 Huntington Ave.
Boston, MA 02115
617-373-4775 (Phone)

Christof W. Stahel

Investment Company Institute ( email )

1401 H St NW
DC District Of Columbia 20005
United States

Rene M. Stulz (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI)

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