Failure Risk and the Cross-Section of Hedge Fund Returns
نویسنده
چکیده
On average, hedge funds experience slow failures rather than sudden crashes. I model a fund’s probability of failure using a dynamic logit regression and find that fund failures are predicted by even 7-month lagged information. Hedge funds fail slowly as investors withdraw their funds over a period of time because of poor performance. Also, longer share restriction periods and the presence of managerial ownership are associated with lower failure probability. Further, a fund’s failure probability predicts negatively the fund’s future returns. Sorting hedge funds into quintiles by the predicted failure probability based on 7-month lagged information, I find that the return spread (long low failure risk funds and short high failure risk funds) is 7.6~8.2% per year after adjusting for nine risk factors and a return smoothing effect over the period of July 1996 to September 2007. Moreover, the negative relationship between a fund’s failure probability and its future returns is not subsumed by the effects of performance persistence, flow-performance relation, fund age and size, volatility, backfill history, share restrictions, and managerial ownership. * Ph.D. Candidate, The Ohio State University. E-mail: [email protected] Phone: (614) 292-7562. I thank Kewei Hou and the participants in the Finance 923 seminar at the Ohio State University for useful comments. I am especially indebted to my advisor, René Stulz, for his suggestions. The Dice Center for Financial Economics provided financial support. All remaining errors are my own.
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