Are hedge funds active market liquidity timers?

Chenlu Li, Baibing Li and Kai-Hong Tee

International Review of Financial Analysis, 2020, vol. 67, issue C

Abstract: This paper investigates liquidity timing behaviour of hedge funds that invest globally in foreign investment assets. We expect these hedge funds to manage currencies exposure differently, depending on the extent they treat them as an asset class. In this paper, we investigate if actively timing foreign exchange (FX) liquidity adds value to hedge funds' investments. Unlike the existing studies where fund managers are assumed to either time or not time the market over the entire study period, we argue that fund managers may strategically choose to be active market liquidity timers based on the market condition at the time. To test this hypothesis, we develop a state-dependent liquidity timing model embedded with a Markov regime switching process and identify changes in the FX liquidity timing behaviour among the Global Derivatives hedge funds over an eighteen-year period. Our findings reveal that such regime changes in timing behaviour are driven by the underlying FX liquidity condition. A further analysis to compare the changes in the timing behaviour over time shows that hedge funds that are active market liquidity timers outperform those that engage in liquidity timing less frequently in all strategies categories.

Keywords: Foreign exchange market; Hedge fund; Liquidity; Markov regime switching; Timing behaviour (search for similar items in EconPapers)
JEL-codes: F3 G1 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:67:y:2020:i:c:s1057521918306641

DOI: 10.1016/j.irfa.2019.101415

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