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Investible benchmarks & hedge fund liquidity

Author

Listed:
  • Freed, Marc S
  • McMillan, Ben

Abstract

A lack of commonly accepted benchmarks for hedge fund performance has permitted hedge fund managers to attribute to skill returns that may actually accrue from market risk factors and illiquidity. Recent innovations in hedge fund replication permits us to estimate the extent of this misattribution. Using an option-based model, we find evidence that the value of liquidity options that investors implicitly grant managers when they invest may account for part or even all hedge fund returns. Coupled with the competition from hedge fund replication vehicles, this finding may motivate hedge fund investors to demand less restrictive investment terms in the future.

Suggested Citation

  • Freed, Marc S & McMillan, Ben, 2011. "Investible benchmarks & hedge fund liquidity," MPRA Paper 32226, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:32226
    as

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    References listed on IDEAS

    as
    1. Stephen Brown & William Goetzmann, 2001. "Hedge Funds With Style," Yale School of Management Working Papers ysm21, Yale School of Management, revised 01 Apr 2008.
    2. Longstaff, Francis A, 1995. "How Much Can Marketability Affect Security Values?," Journal of Finance, American Finance Association, vol. 50(5), pages 1767-1774, December.
    3. Fung, William & Hsieh, David A., 2000. "Performance Characteristics of Hedge Funds and Commodity Funds: Natural vs. Spurious Biases," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(3), pages 291-307, September.
    4. William Fung & David A. Hsieh, 2004. "Hedge Fund Benchmarks: A Risk-Based Approach," Financial Analysts Journal, Taylor & Francis Journals, vol. 60(5), pages 65-80, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    hedge funds; replication; alpha; exotic beta; hedge fund beta; liquidity; illiquidity; marketability; accessibility; redemption terms;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services

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