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The economics of hedge funds

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  • Lan, Yingcong
  • Wang, Neng
  • Yang, Jinqiang

Abstract

Hedge fund managers trade off the benefits of leveraging on the alpha-generating strategy against the costs of inefficient fund liquidation. In contrast to the standard risk-seeking intuition, even with a constant-return-to-scale alpha-generating strategy, a risk-neutral manager becomes endogenously risk-averse and decreases leverage following poor performance to increase the fund's survival likelihood. Our calibration suggests that management fees are the majority of the total compensation. Money flows, managerial restart options, and management ownership increase the importance of high-water-mark-based incentive fees but management fees remain the majority. Investors' valuation of fees are highly sensitive to their assessments of the manager's skill.

Suggested Citation

  • Lan, Yingcong & Wang, Neng & Yang, Jinqiang, 2013. "The economics of hedge funds," Journal of Financial Economics, Elsevier, vol. 110(2), pages 300-323.
  • Handle: RePEc:eee:jfinec:v:110:y:2013:i:2:p:300-323
    DOI: 10.1016/j.jfineco.2013.05.004
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Aiken, Adam L. & Clifford, Christopher P. & Ellis, Jesse A., 2015. "Hedge funds and discretionary liquidity restrictions," Journal of Financial Economics, Elsevier, vol. 116(1), pages 197-218.
    2. Mark D. Flood & Phillip Monin, 2016. "Form PF and Hedge Funds: Risk-measurement Precision for Option Portfolios," Working Papers 16-02, Office of Financial Research, US Department of the Treasury.
    3. Hong, Xin, 2014. "The dynamics of hedge fund share restrictions," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 82-99.
    4. repec:eee:ecmode:v:68:y:2018:i:c:p:599-610 is not listed on IDEAS
    5. Ewald, Christian-Oliver & Zhang, Hai, 2016. "Hedge fund seeding via fees-for-seed swaps under idiosyncratic risk," Journal of Economic Dynamics and Control, Elsevier, vol. 71(C), pages 45-59.
    6. Mark D. Flood & Phillip Monin & Lina Bandyopadhyay, 2015. "Gauging Form PF: Data Tolerances in Regulatory Reporting on Hedge Fund Risk Exposures," Working Papers 15-13, Office of Financial Research, US Department of the Treasury.
    7. Morten Sorensen & Neng Wang & Jinqiang Yang, 2014. "Valuing Private Equity," Review of Financial Studies, Society for Financial Studies, vol. 27(7), pages 1977-2021.
    8. repec:kap:fmktpm:v:32:y:2018:i:2:d:10.1007_s11408-018-0309-4 is not listed on IDEAS

    More about this item

    Keywords

    High-water mark (HWM); Alpha; Management fees; Incentive fees; Liquidation risk; New money flow;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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