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Hedge Fund Return Dependence: Model Misspecification or Liquidity Spirals?

Published online by Cambridge University Press:  02 October 2017

Abstract

We test whether model misspecification or liquidity spirals primarily explain the observed excess dependence in filtered (for economic fundamentals) hedge fund index returns and the links between volatility, liquidity shocks, and hedge fund return clustering. Evidence supports the model misspecification hypothesis: i) hedge fund filtered return clustering is symmetric, ii) filtered Short Bias fund returns exhibit negative dependence with filtered returns for other hedge fund types, iii) negative liquidity shocks are associated with clustering in both tails and market volatility subsumes the role of negative liquidity shocks, and iv) these same patterns appear in size-sorted equity portfolios.

Type
Research Article
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

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Footnotes

1

We thank George Aragon (WFA discussant), Phelim Boyle, Stephen Brown (the editor), Neal Stoughton, seminar participants at the 2014 Western Finance Association (WFA) meetings, and especially an anonymous referee for their helpful comments.

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