Hedge-Fund Performance and Liquidity Risk

Journal of Investment Management (JOIM), Second Quarter 2012

Posted: 2 Jun 2012

See all articles by Ronnie Sadka

Ronnie Sadka

Boston College - Carroll School of Management

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Date Written: June 1, 2012

Abstract

This paper demonstrates that liquidity risk as measured by the covariation of fund returns with unexpected changes in aggregate liquidity is an important predictor of hedge-fund performance. The results show that funds that significantly load on liquidity risk subsequently outperform low-loading funds by about 6.5% annually, on average, over the period 1994-2009, while negative performance is observed during liquidity crises. The returns are independent of share restriction, pointing to a possible imbalance between the liquidity a fund offers its investors and the liquidity of its underlying positions. Liquidity risk seems to account for a substantial part of hedge-fund performance. The results suggest several practical implications for risk management and manager selection.

Keywords: Hedge funds, liquidity risk, share restriction, manager selection, risk management

JEL Classification: G00

Suggested Citation

Sadka, Ronnie, Hedge-Fund Performance and Liquidity Risk (June 1, 2012). Journal of Investment Management (JOIM), Second Quarter 2012, Available at SSRN: https://ssrn.com/abstract=2072774

Ronnie Sadka (Contact Author)

Boston College - Carroll School of Management ( email )

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Chestnut Hill, MA 02467
United States

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