Failure Risk and the Cross-Section of Hedge Fund Returns

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Abstract

Modeling a hedge fund's probability of failure with a dynamic logit regression, I find that the probability of a fund's failure has a significantly negative effect on the fund's future returns. A quintile portfolio with the highest failure probability underperforms a quintile portfolio with the lowest failure probability by 5% to 6% per year from 1997 to 2012. The results are robust to the definition of hedge fund failure and controlling for a large set of risk factors and fund characteristics. Moreover, the negative effect of failure probability on future fund returns is stronger for funds with weak share restrictions.

Original languageEnglish
Pages (from-to)845-876
Number of pages32
JournalFinancial Management
Volume45
Issue number4
DOIs
StatePublished - 1 Dec 2016

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