Hedge Funds and Prime Broker Risk
51 Pages Posted: 19 Jun 2019 Last revised: 9 Jan 2024
Date Written: January 7, 2023
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: Suggested Citation