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Do Hedge Funds Supply or Demand Liquidity?

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  • Petri Jylhä
  • Kalle Rinne
  • Matti Suominen

Abstract

Regressing hedge funds’ returns on returns to a long–short contrarian trading strategy, a measure of the returns from providing liquidity, we find that hedge funds typically supply liquidity in the stock market. In the cross-section, strict redemption restrictions and large fund size increase funds’ propensity to supply liquidity. In time series, poor market liquidity and good funding conditions increase funds’ propensity to supply liquidity. Although the hedge funds typically supply liquidity, during crises they demand liquidity. We also find that increases in the amount of speculative capital improve market liquidity and reduce the amount of short-term return reversals and volatility.

Suggested Citation

  • Petri Jylhä & Kalle Rinne & Matti Suominen, 2014. "Do Hedge Funds Supply or Demand Liquidity?," Review of Finance, European Finance Association, vol. 18(4), pages 1259-1298.
    • Handle: RePEc:oup:revfin:v:18:y:2014:i:4:p:1259-1298.
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