The liquidity risk of liquid hedge funds

This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79% per year after adjusting for risk. The return impact of fund flows is stronger when funds em...

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Bibliographic Details
Published in:Journal of financial economics 2011-04, Vol.100 (1), p.24-44
Main Author: Teo, Melvyn
Format: Article
Language:English
Subjects:
Capital accumulation
Finance
Funding liquidity
Hedge funds
Hedge funds Liquidity risk Funding liquidity Market liquidity Redemption gates
Investment
Investors
Liquidity
Liquidity risk
Macroeconomics
Market liquidity
Market theory
Rates of return
Redemption gates
Risk
Risk assessment
Studies
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Summary:This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79% per year after adjusting for risk. The return impact of fund flows is stronger when funds embrace liquidity risk, when market liquidity is low, and when funding liquidity, as measured by the Treasury-Eurodollar spread, aggregate hedge fund flows, and prime broker stock returns, is tight. In keeping with an agency explanation, funds with strong incentives to raise capital, low manager option deltas, and no manager capital co-invested are more likely to take on excessive liquidity risk. These results resonate with the theory of funding liquidity by Brunnermeier and Pedersen (2009).
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2010.11.003