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Managing Hedge Fund Liquidity Risks
1 : University Paris-Dauphine
Université Paris-Dauphine, PSL Research University
2 : McGill University
* : Corresponding author
We study hedge fund optimal portfolios in the presence of market and funding liquidity risks. We consider a two-period economy with a single hedge fund. The fund has access to cash which is available every period and to an illiquid asset which pays o only at the end of the second period. Funding liquidity risk takes the form of a random proportion of the fund's assets under management being withdrawn by clients in period one. The fund can then liquidate a part of the illiquid position by bidding on a secondary market where a random haircut on the eective selling price is applied. We solve the allocation problem of the fund and nd its optimal portfolio. Whereas the cash buer is monotonously decreasing in the secondary market liquidity, we show that the fund's default probability is bell-shaped. Finally, we apply our model in an asset pricing framework for dierent hedge fund strategies to see how both risks are priced over time.
