Hedge Funds and Discretionary Liquidity Restrictions

53 Pages Posted: 6 Dec 2012 Last revised: 24 Aug 2013

See all articles by Adam L. Aiken

Adam L. Aiken

Elon University

Christopher P. Clifford

University of Kentucky

Jesse A. Ellis

North Carolina State University

Date Written: August 24, 2013


During the recent financial crisis, more than 30% of hedge fund managers in our sample exercised discretionary authority to restrict investor liquidity using mechanisms such as side pockets and gates. Using a hand-collected dataset of hedge fund investor interests, we examine the determinants of these discretionary liquidity restrictions (DLRs) and their consequences for investors and hedge fund managers. We find that funds restrict liquidity when facing greater funding and asset liquidity risk, consistent with funds using DLRs to prevent potentially damaging runs on the fund's capital. However, we also find DLRs to be more prevalent among funds with greater potential for conflicts of interest with investors. Further, we find that DLR funds underperform both a passive benchmark and a control sample of similar funds subsequent to initiating the DLR. Our evidence suggests DLRs negatively impact fund family reputation, as funds associated with DLR activity had a more difficult time raising capital and were more likely to cut their fees in the post-crisis era.

Keywords: Hedge funds, liquidity

JEL Classification: G23

Suggested Citation

Aiken, Adam L. and Clifford, Christopher P. and Ellis, Jesse A., Hedge Funds and Discretionary Liquidity Restrictions (August 24, 2013). Available at SSRN: https://ssrn.com/abstract=2185999 or http://dx.doi.org/10.2139/ssrn.2185999

Adam L. Aiken

Elon University ( email )

100 Campus Drive
Elon, NC 27244
United States

Christopher P. Clifford (Contact Author)

University of Kentucky ( email )

College of Business & Economics
Lexington, KY 40506-0034
United States
859-257-3850 (Phone)

Jesse A. Ellis

North Carolina State University ( email )

Poole College of Management
Campus Box 7229
Raleigh, NC 27695
United States
919-515-9670 (Phone)

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