55 Pages Posted: 22 Jan 2010 Last revised: 18 Feb 2015
Date Written: November 20, 2012
We explore a new dimension of fund managers’ timing ability by examining whether they can time market liquidity through adjusting their portfolios’ market exposure as aggregate liquidity conditions change. Using a large sample of hedge funds, we find strong evidence of liquidity timing. A bootstrap analysis suggests that top-ranked liquidity timers cannot be attributed to pure luck. In out-of-sample tests, top liquidity timers outperform bottom timers by 4.0%–5.5% annually on a risk-adjusted basis. We also find that it is important to distinguish liquidity timing from liquidity reaction which primarily relies on public information. Our results are robust to alternative explanations, hedge fund data biases, and the use of alternative timing models, risk factors, and liquidity measures. The findings highlight the importance of understanding and incorporating market liquidity conditions in investment decision-making.
Keywords: Hedge funds, liquidity timing, investment value, liquidity reaction, performance persistence
JEL Classification: G23, G11
Suggested Citation: Suggested Citation
Cao, Charles and Chen, Yong and Liang, Bing and Lo, Andrew W., Can Hedge Funds Time Market Liquidity? (November 20, 2012). Journal of Financial Economics (JFE), Forthcoming; AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1537925 or http://dx.doi.org/10.2139/ssrn.1537925
By Andrew Ang