Hedge Funds and Prime Broker Risk

51 Pages Posted: 19 Jun 2019 Last revised: 9 Jan 2024

See all articles by Magnus Dahlquist

Magnus Dahlquist

Stockholm School of Economics; Swedish House of Finance

Simon Rottke

University of Amsterdam - Finance Group; Tinbergen Institute

Valeri Sokolovski

University of Alberta

Erik Sverdrup

Stanford University

Date Written: January 7, 2023

Abstract

We show that large adverse shocks to an individual prime broker only impact the performance of hedge funds using the affected broker exclusively, highlighting the diversifiability of idiosyncratic shocks. Conversely, we find systematic financial intermediary risk a significant determinant in the cross-section of hedge fund returns. Moreover, the average hedge fund's exposure to this risk exceeds the aggregate risk of its holdings. This incremental exposure is asymmetric, driven solely by negative intermediary shocks. In contrast, mutual funds and other risk factors show no similar effect. Our findings underscore the unique risks of hedge funds due to their prime brokerage dependencies.

Keywords: Hedge funds, financial intermediary risk, prime brokers, systematic risk, idiosyncratic risk.

JEL Classification: G12, G23, G24.

Suggested Citation

Dahlquist, Magnus and Rottke, Simon and Sokolovski, Valeri and Sverdrup, Erik, Hedge Funds and Prime Broker Risk (January 7, 2023). Swedish House of Finance Research Paper No. 19-8, Available at SSRN: https://ssrn.com/abstract=3396632 or http://dx.doi.org/10.2139/ssrn.3396632

Magnus Dahlquist

Stockholm School of Economics ( email )

Drottninggatan 98
Stockholm, SE-111 60
Sweden

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Simon Rottke

University of Amsterdam - Finance Group ( email )

Roetersstraat 18
Amsterdam, 1018 WB
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Valeri Sokolovski (Contact Author)

University of Alberta ( email )

Edmonton, Alberta T6G 2R3
Canada

Erik Sverdrup

Stanford University ( email )

Stanford, CA 94305
United States

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