Abstract
I investigate whether hedge funds that supply liquidity earn superior returns. Using transaction data, I find that hedge funds following short-term contrarian strategies (i.e., liquidity suppliers) earn significantly higher returns on their equity trades and holdings. Similarly, using commercial databases, I find that hedge funds with greater exposure to a liquidity provision factor earn significantly higher excess returns and Sharpe ratios. The superior performance of liquidity-supplying hedge funds arises from strategies that are more complex than mechanical short-term reversal strategies. For example, among stocks with similar past returns, liquidity-supplying funds are more likely to trade against stocks heavily traded by constrained mutual funds and less likely to trade against stocks heavily traded by unconstrained mutual funds. The outperformance of liquiditysupplying funds is also concentrated in periods of low funding liquidity, suggesting that less-binding financial constraints contribute to their superior returns.
Original language | English |
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Pages (from-to) | 3288-3312 |
Number of pages | 25 |
Journal | Management Science |
Volume | 64 |
Issue number | 7 |
DOIs | |
State | Published - Jul 2018 |
Bibliographical note
Publisher Copyright:© 2017 INFORMS.
Keywords
- Fund performance
- Hedge funds
- Liquidity provision
ASJC Scopus subject areas
- Strategy and Management
- Management Science and Operations Research