Hedge Fund Alphas: Do They Reflect Managerial Skills or Mere Compensation for Liquidity Risk Bearing?
67 Pages Posted: 21 Nov 2008 Last revised: 24 Mar 2010
Date Written: March 19, 2010
Abstract
This article analyzes the effect of liquidity risk on the performance of various hedge fund portfolio strategies. Similarly to Avramov et al. (2007), we find that, before accounting for the effect of liquidity risk, hedge fund portfolios that incorporate predictability in managerial skills generate superior performance. This outperformance disappears or weakens dramatically for six out of ten hedge fund style-based portfolios once we account for liquidity risk. Hence, for most hedge fund portfolios, “alphas” represent a compensation for liquidity risk bearing. These results are robust to an alternative performance evaluation model and to an alternative liquidity risk proxy.
Keywords: Hedge Funds, Liquidity Risk, Managerial Skills, Predictability
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation
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