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Hedge Fund Contagion and Liquidity

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  • Boyson, Nicole M.

    (Northeastern U)

  • Stahel, Christof W.

    (George Mason U)

  • Stulz, Rene

    (Ohio State U)

Abstract

Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.

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Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2008-8.

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Date of creation: May 2008
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Handle: RePEc:ecl:ohidic:2008-8

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Cited by:
  1. Franklin Allen & Ana Babus & Elena Carletti, 2010. "Financial Connections and Systemic Risk," NBER Working Papers 16177, National Bureau of Economic Research, Inc.
  2. Leila Gharbi & Khamoussi Halioui, 2011. "La juste valeur des instruments financiers : Un nouveau canal de contagion ?," Post-Print hal-00650435, HAL.
  3. Baur, Dirk G. & Fry, Renée A., 2009. "Multivariate contagion and interdependence," Journal of Asian Economics, Elsevier, vol. 20(4), pages 353-366, September.

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