Share Restrictions, Liquidity Premium and Offshore Hedge Funds

This paper examines liquidity premium focusing on the difference between offshore and onshore hedge funds. Due to tax provisions and regulatory concerns, offshore and onshore hedge funds have different legal structures, which lead to differences in share restrictions such as a lockup provision. We find that offshore investors collect higher illiquidity premium when their investment has the same level of share illiquidity as the investment of onshore investors. Introducing a lockup provision increases the abnormal return by 4.4% per year for offshore funds compared with only 2.7% for onshore funds during the period of 1994-2005. We argue that the difference is explained by the stronger relationship between share illiquidity and asset illiquidity in offshore hedge funds. We also find that the benefit of offshore investors is maximized when they invest in offshore hedge funds that are not affected by onshore funds through a masterfeeder structure.