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Unsmoothing Returns of Illiquid Funds

Author

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  • Spencer J Couts
  • Andrei S Gonçalves
  • Andrea Rossi

Abstract

Funds investing in illiquid assets report returns with spurious autocorrelation. Consequently, investors need to unsmooth these funds’ returns when evaluating their risk exposures. We show that funds with similar investments share a common source of spurious autocorrelation not fully resolved by traditional unsmoothing methods and thereby leading to underestimation of systematic risk. Thus, we propose a generalized unsmoothing technique and apply it to hedge funds and private commercial real estate funds. Our method significantly improves the measurement of funds’ risk exposures and risk-adjusted performance, especially for highly illiquid funds. Overall, the average illiquid fund alpha is lower than previously thought. (JEL G11, G12, G23)

Suggested Citation

  • Spencer J Couts & Andrei S Gonçalves & Andrea Rossi, 2024. "Unsmoothing Returns of Illiquid Funds," The Review of Financial Studies, Society for Financial Studies, vol. 37(7), pages 2110-2155.
    • Handle: RePEc:oup:rfinst:v:37:y:2024:i:7:p:2110-2155.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhae006
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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