High Funding Risk, Low Return
62 Pages Posted: 11 Nov 2016 Last revised: 11 May 2021
Date Written: August 30, 2019
I show that hedge funds with a high exposure to market-wide funding shocks - measured by changes in LIBOR-OIS spreads - subsequently underperform funds with a low exposure to market-wide funding shocks by 5.76% annually on a risk-adjusted basis (t=4.04). To explain this puzzling result, I hypothesize that this type of funding risk exposure is connected to hedge funds' liabilities with limited upside in normal times and severe downside risk during funding crises. Supporting this hypothesis, the performance difference between low-funding-risk and high-funding-risk funds is largest when funding constraints are most binding and for funds with more fragile liabilities.
Keywords: Funding Risk, Hedge Funds, Interbank Risk, Libor, Liquidity
JEL Classification: G01, G23, G31
Suggested Citation: Suggested Citation