Liquidity Timing
Can Hedge Funds Time Market Liquidity?
ABSTRACT – Charles Cao and et al.
“We explore a new dimension of hedge fund managers’ timing ability—their ability to time market liquidity—and examine whether fund managers can time liquidity by adjusting their portfolios’ market exposure as aggregate market liquidity conditions change. Using a large sample of equity-oriented hedge funds from 1994 to 2009, we find strong evidence of liquidity timing. The results from a bootstrap analysis suggest that the evidence of top-ranked liquidi-ty timers cannot be attributed purely to sampling variation or luck. This liquidity-timing skill persists over time, and in out-of-sample tests, top liquidity-timing funds outperform bot-tom liquidity-timing funds by 4.0% to 5.5% annually on a risk-adjusted basis. These results are robust to alternative explanations, to the use of alternative timing-model specifications, risk factors, and liquidity measures, as well as to hedge fund data biases such as survivorship bias and backfill bias.”
STARisk 