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Hedge Funds Performance Ratios Adjusted to Market Liquidity Risk

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Abstract

Market liquidity is complex to measure empirically. This explains why there is no consensus about performance ratios adjusted to its risk. We summarize market liquidity by two major characteristics: a costly one because of the loss of the illiquidity premium; and a profitable one when investors can withdraw when they want. In this paper, three new performance indicators are proposed to integrate, to a certain extent, market liquidity risk, especially for hedge funds investment: liquidity-loss ratio will capture the cost characteristic whereas liquidity-Sharpe ratio and liquidity-profit ratio will represent the profitable alternative. These new ratios try to be simple and precise enough to help investors choose between hedge funds strategies according to their liquidity profile: do they want to capture illiquidity risk premium, or do they want to be free to withdraw?

Suggested Citation

  • Clauss, Pierre, 2011. "Hedge Funds Performance Ratios Adjusted to Market Liquidity Risk," Journal of Financial Transformation, Capco Institute, vol. 31, pages 133-139.
    • Handle: RePEc:ris:jofitr:1454
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    Keywords

    Market liquidity risk; Hedge funds; Sharpe ratio; Information ratio; Kalman Filter; Momentum.;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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