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Can Liquidity Risk Explain Diseconomies of Scale in Hedge Funds?

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  • Hany A. Shawky

    (Center for Institutional Investment Management (CIIM) and School of Business, University at Albany, State University of New York, Albany, NY, USA)

  • Ying Wang

    (Center for Institutional Investment Management (CIIM) and School of Business, University at Albany, State University of New York, Albany, NY, USA)

Abstract
Using data from the Lipper TASS hedge fund database over the period 1994–2012, we examine the role of liquidity risk in explaining the relation between asset size and hedge fund performance. While a significant negative size-performance relation exists for all hedge funds, once we stratify our sample by liquidity risk, we find that such a relationship only exists among funds with the highest liquidity risk. Liquidity risk is found to be another important source of diseconomies of scale in the hedge fund industry. Evidently, for high liquidity risk funds, large funds are less able to recover from the relatively more significant losses incurred during market-wide liquidity crises, resulting in lower performance for large funds relative to small funds.

Suggested Citation

  • Hany A. Shawky & Ying Wang, 2017. "Can Liquidity Risk Explain Diseconomies of Scale in Hedge Funds?," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 7(02), pages 1-35, June.
    • Handle: RePEc:wsi:qjfxxx:v:07:y:2017:i:02:n:s2010139217500021
    DOI: 10.1142/S2010139217500021
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    Cited by:

    1. Malakhov, Alexey & Riley, Timothy B. & Yan, Qing, 2024. "Do hedge funds bet against beta?," International Review of Economics & Finance, Elsevier, vol. 93(PA), pages 1507-1525.

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