Working Paper: NBER ID: w14068
Authors: Nicole M. Boyson; Christof W. Stahel; Rene M. Stulz
Abstract: Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.
Keywords: Hedge Funds; Contagion; Liquidity; Risk Management
JEL Codes: G11; G12; G18; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| main markets (F19) | hedge fund styles (G11) |
| count of other indices experiencing extreme poor performance (P47) | probability of hedge fund style index falling into the lower 10% tail (C46) |
| liquidity (E41) | contagion among hedge fund styles (C92) |
| asset and funding liquidity (G32) | average number of hedge fund styles with extreme negative returns (C46) |