Hostname: page-component-78c5997874-94fs2 Total loading time: 0 Render date: 2024-11-15T10:19:06.438Z Has data issue: false hasContentIssue false
  • English
  • Français

Funding Liquidity Risk and the Dynamics of Hedge Fund Lockups

Published online by Cambridge University Press:  04 September 2020

Adam L. Aiken ,
Christopher P. Clifford ,
Jesse A. Ellis Open the ORCID record for Jesse A. Ellis [Opens in a new window]  and
Qiping Huang
Adam L. Aiken
Affiliation:
Elon University Martha & Spencer Love School of Businessadam.aiken@gmail.com
Christopher P. Clifford
Affiliation:
University of Kentucky Gatton College of Business and Economicschris.clifford@uky.edu
Jesse A. Ellis*
Affiliation:
North Carolina State University Poole College of Managementjaellis5@ncsu.edu
Qiping Huang
Affiliation:
Boise State University College of Business and Economicsqipinghuang@boisestate.edu
*
jaellis5@ncsu.edu (corresponding author)
Get access Rights & Permissions [Opens in a new window]

Abstract

We exploit the expiring nature of hedge fund lockups to create a new measure of funding liquidity risk that varies within funds. We find that hedge funds with lower funding risk generate higher returns, and this effect is driven by their increased exposure to equity-mispricing anomalies. Our results are robust to a variety of sampling criteria, variable definitions, and control variables. Further, we address endogeneity concerns in various ways, including a placebo approach and regression discontinuity design. Collectively, our results support a causal link between funding risk and the ability of managers to engage in risky arbitrage.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 4 , June 2021 , pp. 1321 - 1349
Copyright
© THE AUTHOR(S), 2020. PUBLISHED BY CAMBRIDGE UNIVERSITY PRESS ON BEHALF OF THE MICHAEL G. FOSTER SCHOOL OF BUSINESS, UNIVERSITY OF WASHINGTON

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank seminar participants at the University of Melbourne, the University of Technology Sydney, the University of Tennessee, Rensselaer Polytechnic Institute, Florida International University, the 2016 Financial Risks International Forum, the 2016 Annual Hedge Fund Conference, and the 2018 Southern Finance Association Meeting. We thank Vikas Agarwal, George Aragon, Nick Bollen, Will Gerken, Russell Jame, Spencer Martin, Naryan Naik, Andy Puckett, Francois-Eric Racicot (discussant), Honglin Ren (discussant), Kalle Rinne (discussant), and Thomas Shohfi for their comments and an anonymous pension fund for supplying a sample of liquidity contracts.

References

Agarwal, V.; Daniel, N.; and Naik, N.. “Role of Managerial Incentives and Discretion in Hedge Fund Performance.” Journal of Finance, 64 (2009), 2221–2256.CrossRefGoogle Scholar
Agarwal, V.; Ruenzi, S.; and Weigert, F.. “Tail Risk in Hedge Funds: A Unique View from Portfolio Holdings.” Journal of Financial Economics, 125 (2017), 610–636.CrossRefGoogle Scholar
Aggarwal, R., and Jorion, P.. “The Performance of Emerging Hedge Funds and Managers.” Journal of Financial Economics, 96 (2010), 238–256.CrossRefGoogle Scholar
Aiken, A.; Clifford, C.; and Ellis, J.. “Hedge Funds and Discretionary Liquidity Restrictions.” Journal of Financial Economics, 116 (2015), 197–218.CrossRefGoogle Scholar
Akbas, F.; Armstrong, W.; Sorescu, S.; and Subrahmanyam, A.. “Smart Money, Dumb Money, and Capital Market Anomalies.” Journal of Financial Economics, 118 (2015), 355–382.CrossRefGoogle Scholar
Akbas, F.; Armstrong, W.; Sorescu, S.; and Subrahmanyam, A.. “Capital Market Efficiency and Arbitrage Efficacy.” Journal of Financial and Quantitative Analysis, 51 (2016), 387–413.CrossRefGoogle Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Amihud, Y. “Illiquidity and Stock Returns: A Revisit.” Critical Finance Review, 8 (2019), 1–19.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “Asset Pricing and the Bid–Ask Spread.” Journal of Financial Economics, 17 (1986), 223–249.CrossRefGoogle Scholar
Angrist, J., and Krueger, A.. “Instrumental Variables and the Search for Identification: From Supply and Demand to Natural Experiments.” Journal of Economic Perspectives, 15 (2001), 69–85.CrossRefGoogle Scholar
Aragon, G. “Share Restrictions and Asset Pricing: Evidence from the Hedge Fund Industry.” Journal of Financial Economics, 83 (2007), 33–58.CrossRefGoogle Scholar
Aragon, G.; Martin, J. S.; and Shi, Z.. “Who Benefits in a Crisis? Evidence from Hedge Fund Stock and Option Holdings.” Journal of Financial Economics, 131 (2019), 345–361.CrossRefGoogle Scholar
Asness, C. S.; Krail, R. J.; and Liew, J. M.. “Do Hedge Funds Hedge?” Journal of Portfolio Management, 28 (2001), 6–19.CrossRefGoogle Scholar
Ben-David, I.; Franzoni, F.; and Moussawi, R.. “Hedge Fund Stock Trading in the Financial Crisis of 2007–2009.” Review of Financial Studies, 25 (2012), 1–54.CrossRefGoogle Scholar
Boyson, N. “Do Hedge Funds Exhibit Performance Persistence? A New Approach.” Financial Analysts Journal, 64 (2008), 15–26.CrossRefGoogle Scholar
Brunnermeier, M., and Pedersen, L.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 2201–2238.CrossRefGoogle Scholar
Cherkes, M.; Sagi, J.; and Stanton, R.. “A Liquidity-Based Theory of Closed-End Funds.” Review of Financial Studies, 22 (2009), 257–297.CrossRefGoogle Scholar
Cotelioglu, E.; Franzoni, F.; and Plazzi, A.. “What Constrains Liquidity Provision? Evidence from Institutional Trades.” Working Paper, Swiss Finance Institute (2002).Google Scholar
Daniel, K., and Moskowitz, T.. “Momentum Crashes.” Journal of Financial Economics, 122 (2016), 221–247.CrossRefGoogle Scholar
Fung, W., and Hsieh, D.. “Hedge Fund Benchmarks: A Risk-Based Approach.” Financial Analysts Journal, 60 (2004), 60–80.CrossRefGoogle Scholar
Getmansky, M.; Lo, A.; and Makarov, I.. “An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns.” Journal of Financial Economics, 74 (2004), 529–609.CrossRefGoogle Scholar
Giannetti, M., and Kahraman, B.. “Open-End Organizational Structures and Limits to Arbitrage.” Review of Financial Studies, 31 (2018), 773–810.CrossRefGoogle Scholar
Hahn, J.; Todd, P.; and Van der Klaauw, W.. “Identification and Estimation of Treatment Effects with a Regression-Discontinuity Design.” Econometrica, 69 (2001), 201–209.CrossRefGoogle Scholar
Hombert, J., and Thesmar, D.. “Overcoming Limits of Arbitrage: Theory and Evidence.” Journal of Financial Economics, 111 (2014), 26–44.CrossRefGoogle Scholar
Hong, X. “The Dynamics of Hedge Fund Share Restrictions.” Journal of Banking and Finance, 49 (2014), 82–99.CrossRefGoogle Scholar
Hou, K.; Xue, C.; and Zhang, L.. “Digesting Anomalies: An Investment Approach.” Review of Financial Studies, 28 (2015), 650–705.CrossRefGoogle Scholar
Joenvävärä, J.; Kosowski, R.; and Tolonen, P.. “Hedge Fund Performance: What Do We Know?” Working Paper, Imperial College London (2016).Google Scholar
Joenvävärä, J.; Kosowski, R.; and Tolonen, P.. “The Effect of Investment Constraints on Hedge Fund Investor Returns.” Journal of Financial and Quantitative Analysis, 54 (2019), 1539–1571.CrossRefGoogle Scholar
Khandani, A., and Lo, A.. “What Happened to the Quants in August 2007? Evidence from Factors and Transaction Data.” Journal of Financial Markets, 14 (2011), 1–46.CrossRefGoogle Scholar
Linnainmaa, J., and Moreira, A.. “Hedge Funds, Signaling, and Optimal Lockups.” Working Paper, available at https://pdfs.semanticscholar.org/7315/9c1290ae009d028d5a8c1db1b5c0950b280f.pdf (2017).Google Scholar
Shleifer, A., and Vishny, R.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.CrossRefGoogle Scholar
Stambaugh, R.; Yu, J.; and Yuan, Y.. “The Short of It: Investor Sentiment and Anomalies.” Journal of Financial Economics, 104 (2012), 288–302.CrossRefGoogle Scholar
Stambaugh, R.; Yu, J.; and Yuan, Y.. “Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle.” Journal of Finance, 70 (2015), 1903–1948.CrossRefGoogle Scholar
Stambaugh, R., and Yuan, Y.. “Mispricing Factors.” Review of Financial Studies, 30 (2017), 1270–1315.CrossRefGoogle Scholar