Can hedge funds time market liquidity?

Charles Cao, Yong Chen, Bing Liang, Andrew W. Lo

Research output: Contribution to journalArticle

74 Scopus citations

Abstract

We explore a new dimension of fund managers' timing ability by examining whether they can time market liquidity through adjusting their portfolios' market exposure as aggregate liquidity conditions change. Using a large sample of hedge funds, we find strong evidence of liquidity timing. A bootstrap analysis suggests that top-ranked liquidity timers cannot be attributed to pure luck. In out-of-sample tests, top liquidity timers outperform bottom timers by 4.0-5.5% annually on a risk-adjusted basis. We also find that it is important to distinguish liquidity timing from liquidity reaction, which primarily relies on public information. Our results are robust to alternative explanations, hedge fund data biases, and the use of alternative timing models, risk factors, and liquidity measures. The findings highlight the importance of understanding and incorporating market liquidity conditions in investment decision making.

Original languageEnglish (US)
Pages (from-to)493-516
Number of pages24
JournalJournal of Financial Economics
Volume109
Issue number2
DOIs
StatePublished - Aug 1 2013

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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