Unsmoothing Returns of Illiquid Funds
USC Lusk Center of Real Estate Working Paper Series
70 Pages Posted: 27 Feb 2020 Last revised: 27 Nov 2020
Date Written: November 25, 2020
Funds that invest in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth returns when evaluating the risk exposures of these funds. We show that funds investing in similar assets have a common source of spurious autocorrelation, which is not addressed by commonly-used unsmoothing methods, leading to underestimation of systematic risk. To address this issue, we propose a generalization of these unsmoothing techniques and apply it to hedge funds and commercial real estate funds. Our empirical results indicate our method significantly improves the measurement of risk exposures and risk-adjusted performance, with stronger results for more illiquid funds.
Keywords: Illiquidity, Return Unsmoothing, Performance Evaluation, Hedge Funds, Commercial Real Estate
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation