Hedge Fund Leverage, Asset Liquidity, and Financial Fragility

68 Pages Posted: 25 Jul 2017

See all articles by Evan Dudley

Evan Dudley

Queen's University - Smith School of Business

Mahendrarajah Nimalendran

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: September 21, 2015

Abstract

Using newly available data on hedge fund leverage that specifies the type of leverage employed (e.g. gross or net), we examine the potential for a credit spiral and financial fragility in hedge funds. We find that funds belonging to fund families that are highly levered, have multiple prime brokers or whose holdings are illiquid have outflows that are over two times more sensitive to prior poor performance than the average hedge fund. Furthermore, negative returns predict future poor returns, and this return persistence is strongest in illiquid and highly leveraged funds. Despite the apparent risks of high leverage that we document, aggregate hedge fund leverage at the end of 2014 exceeded its pre-crisis level even though financial-sector leverage declined over the same period.

Keywords: Hedge fund, leverage, financial fragility, margin, flow-performance, redemption terms, liquidity

JEL Classification: G11, G23

Suggested Citation

Dudley, Evan and Nimalendran, Mahendrarajah, Hedge Fund Leverage, Asset Liquidity, and Financial Fragility (September 21, 2015). Available at SSRN: https://ssrn.com/abstract=3006637 or http://dx.doi.org/10.2139/ssrn.3006637

Evan Dudley (Contact Author)

Queen's University - Smith School of Business ( email )

Goodes Hall
Kingston, Ontario K7L 3N6
Canada

Mahendrarajah Nimalendran

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

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