Working Paper: CEPR ID: DP10151
Authors: Mathias Kruttli; Andrew J. Patton; Tarun Ramadorai
Abstract: This paper provides empirical evidence of the impact of hedge funds on asset markets. We construct a simple measure of the aggregate illiquidity of hedge fund portfolios, and show that it has strong in- and out-of-sample forecasting power for 72 portfolios of international equities, corporate bonds, and currencies over the 1994 to 2013 period. The forecasting ability of hedge fund illiquidity for asset returns is in most cases greater than, and provides independent information relative to, well-known predictive variables for each of these asset classes. We construct a simple equilibrium model based on liquidity provision by hedge funds to noise traders to rationalize our findings, and empirically verify auxiliary predictions of the model.
Keywords: bonds; currencies; equities; hedge funds; liquidity; return predictability
JEL Codes: G11; G12; G14; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| hedge fund illiquidity t (G23) | future asset returns (G12) |
| hedge fund illiquidity t (G23) | expected returns in underlying asset markets (G19) |
| hedge fund illiquidity t (G23) | asset returns across various asset classes (G19) |
| hedge fund illiquidity t (G23) | international equity indexes (G15) |
| hedge fund illiquidity t (G23) | outperforming competitor variables (L15) |