Can Liquidity Risk Explain Diseconomies of Scale in Hedge Funds

Quarterly Journal of Finance, Forthcoming

41 Pages Posted: 30 Sep 2010 Last revised: 8 Sep 2016

See all articles by Hany A. Shawky

Hany A. Shawky

State University of New York at Albany - School of Business and Center for Institutional Investment Management

Ying Wang

State University of New York at Albany - School of Business

Date Written: 2016

Abstract

Using data from the Lipper TASS hedge fund database over 1994-2012, we examine the role of liquidity risk in explaining the relationship between asset size and hedge fund performance. While a significant negative size-performance relationship exists for all hedge funds, once we stratify our sample by liquidity risk, we find that such a relationship only exists among funds with the highest liquidity risk. This result cannot be explained away by the liquidity hypothesis or the leverage effect. Liquidity risk is found to be another important source of diseconomies of scale in the hedge fund industry. Evidently, for high liquidity risk funds, large funds are less able to recover from the more significant losses incurred during market-wide liquidity crises, resulting in lower performance for large funds relative to small funds.

Keywords: Liquidity Risk, Liquidity, Hedge Funds, Asset Size, Performance, Diseconomies of Scale

JEL Classification: G12, G14, G23

Suggested Citation

Shawky, Hany A. and Wang, Ying, Can Liquidity Risk Explain Diseconomies of Scale in Hedge Funds (2016). Quarterly Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1684757 or http://dx.doi.org/10.2139/ssrn.1684757

Hany A. Shawky (Contact Author)

State University of New York at Albany - School of Business and Center for Institutional Investment Management ( email )

School of Business
1400 Washington Ave.
Albany, NY 12222
United States
518-442-4921 (Phone)
518-442-3944 (Fax)

Ying Wang

State University of New York at Albany - School of Business ( email )

1400 Washington Ave.
Albany, NY 12222
United States

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