Liquidity Risk and Mutual Fund Performance

AEA 2012 Chicago Meetings Paper

63 Pages Posted: 15 Mar 2011 Last revised: 15 Jan 2017

Xi Dong

CUNY Baruch College

Shu Feng

Boston University

Ronnie Sadka

Boston College - Carroll School of Management

Date Written: February 6, 2013

Abstract

This paper hypothesizes that market liquidity constrains mutual fund managers' ability to outperform, which introduces a higher liquidity risk exposure (beta) for skilled managers. Consistently, we document an annual liquidity beta performance spread of 4% in the cross-section of mutual funds over the period 1983-2014. Liquidity risk premia based on traditional passive equity portfolios can explain only an insubstantial part of this spread. Instead, the differential ability of high liquidity beta funds to outperform across high and low market liquidity states, whether due to differential rate of mispricing correction or intensity of informed trading, contributes significantly to explaining this spread. The findings highlight the complex effect of liquidity risk on active management.

Keywords: Liquidity risk, Finanical Institutions, Price impact, Asset pricing

JEL Classification: G12, G14

Suggested Citation

Dong, Xi and Feng, Shu and Sadka, Ronnie, Liquidity Risk and Mutual Fund Performance (February 6, 2013). AEA 2012 Chicago Meetings Paper . Available at SSRN: https://ssrn.com/abstract=1785561 or http://dx.doi.org/10.2139/ssrn.1785561

Xi Dong (Contact Author)

CUNY Baruch College ( email )

17 Lexington Avenue
New York, NY 10021
United States

HOME PAGE: http://aux.zicklin.baruch.cuny.edu/dong/

Shu Feng

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Ronnie Sadka

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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