Hedge Fund Contagion and Liquidity Shocks

Abstract

Defining contagion as correlation over and above that expected from economic fundamentals, we find strong evidence of worst return contagion across hedge fund styles for 1990 to 2008. Large adverse shocks to asset and hedge fund liquidity strongly increase the probability of contagion. Specifically, large adverse shocks to credit spreads, the TED spread, prime broker and bank stock prices, stock market liquidity, and hedge fund flows are associated with a significant increase in the probability of hedge fund contagion. While shocks to liquidity are important determinants of performance, these shocks are not captured by commonly used models of hedge fund returns. Copyright (c) 2010 the American Finance Association.

The pricing of sovereign risk and contagion during the European sovereign debt crisis

“…While the residuals in equations (3) and (4) are unsystematic components of the pricing of risk, they may nevertheless provide an indication of herding contagion across countries at certain points in time. Following the approach of Boyson, Stahel and Stulz (2010), we analyze the clustering across countries of large unexplained changes in the pricing of sovereign risk. Herding contagion is present if there are large positive residuals simultaneously, at the same point in time, in several countries.…”

“…More precisely, we employ the approach of Boyson, Stahel and Stulz (2010) and examine the distribution of the residuals from equation (4) across countries at each point in time. In particular, we investigate the presence of tail clustering at the tenth percentile of the distribution, focusing on differences between the non-crisis and crisis periods, and between the euro area and other regions.…”

“…Following the approach of Boyson, Stahel and Stulz (2010), we analyze the clustering in time of large unexplained changes in the pricing of sovereign risk. We find that there is indeed some evidence of such clustering among euro area countries, but that this occurred at the height of the global financial crisis in 2008 and mostly not during 2010 and 2011 with the exception of JulySeptember 2011 when 70% of euro area countries experienced sharp increases in the pricing of their sovereign risk.…”

Econometric measures of connectedness and systemic risk in the finance and insurance sectors

“…Our work is also related to Boyson, Stahel, and Stulz (2010) who investigate contagion from lagged bank-and broker-returns to hedge-fund returns. We consider these relations as well, but also consider the possibility of reverse contagion, i.e., causal effects from hedge funds to banks and broker/dealers.…”

Efficient hedge fund style allocations: A rules-based model

“…6 A market illiquidity measure could be useful in the context of hedge fund style allocation because it constitutes a forward-looking variable and provides information about how investors perceive the future market environment. Boyson et al (2010), Sadka (2010), and Kessler and Scherer (2011) all document that shocks to market liquidity are an important determinant of hedge fund performance. 7 For example, RV contains highly leveraged investment strategies seeking to exploit small spreads within and across different asset classes, and it is thus extremely vulnerable to market illiquidity (Karavas et al, 2005;Agarwal et al, 2010).…”