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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)
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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

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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.

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