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Hedge fund seeding with fees-for-guarantee swaps

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  • Yun Feng
  • Binghua Huang
  • Hai Zhang

Abstract

This paper introduces a new instrument in the context of hedge fund seeding, which we call fees-for-guarantee swap, with the aim of alleviating the early-stage funds (ESF) managers' financial constraint caused by severe asymmetric information between investors and managers. The swap plays a role in enhancing the ESFs manager's credibility by swapping part of her fees for an insurance on the behalf of seeding investors, whom would be fully refunded once the fund defaults. We set up a dynamic continuous-time framework within which closed-form prices for seed capital, guarantee costs and other claims have been derived. Our numerical findings indicate that incentive compensations, managerial ownership and hedge funds liquidation risks not only inhibit ESFs managers' risk-shifting incentive but align interests among ESFs manager, seeder and insurer as well.

Suggested Citation

  • Yun Feng & Binghua Huang & Hai Zhang, 2019. "Hedge fund seeding with fees-for-guarantee swaps," The European Journal of Finance, Taylor & Francis Journals, vol. 25(1), pages 16-34, January.
    • Handle: RePEc:taf:eurjfi:v:25:y:2019:i:1:p:16-34
    DOI: 10.1080/1351847X.2018.1456475
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    Cited by:

    1. Gan, Liu & Xia, Xin & Xu, Mingyu, 2023. "Entrepreneurial investment and financing with third-party guarantees under present-biased preferences," Finance Research Letters, Elsevier, vol. 55(PA).

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