Measuring Hedge Fund Liquidity Mismatch

Abstract

The authors construct a comprehensive measure of mismatch between the market liquidity of assets and the funding liquidity of liabilities of hedge funds. The measure captures the complete liquidity landscape of hedge funds by encompassing liquidity from both sides of the balance sheet. Using quarterly Form Private Fund (PF) filings, they use portfolio, investor, and financing illiquidity to construct the liquidity mismatch measure and study its dynamics from 2013–2015. They find that the market liquidity of a hedge fund’s assets is typically higher than the funding liquidity of its borrowings and investor capital (negative liquidity mismatch). However, liquidity mismatch tends to be greater (more positive) when VIX is high and among funds with higher leverage, lower managerial stake, and smaller size.

TOPICS: Real assets/alternative investments/private equity, risk management, exchanges/markets/clearinghouses, financial crises and financial market history

Key Findings

• ▪ The authors use a unique Form PF dataset with information on portfolio, investor, and financial illiquidity to construct a comprehensive measure of mismatch between the market liquidity of assets and the funding liquidity of liabilities of hedge funds.

• ▪ The authors find that the market liquidity of a hedge fund’s assets is typically higher than the funding illiquidity of its borrowings and investor capital (negative liquidity mismatch).

• ▪ However, liquidity mismatch tends to be greater (more positive) when VIX is high and among funds with higher leverage, lower managerial stake, and smaller size.