Liquidity Risk and Mutual Fund Performance

Xi Dong (), Shu Feng () and Ronnie Sadka ()
Additional contact information
Xi Dong: Baruch College, City University of New York, New York, New York 10010
Shu Feng: Clark University, Worcester, Massachusetts 16010
Ronnie Sadka: Boston College, Chestnut Hill, Massachusetts 02467

Management Science, 2019, vol. 65, issue 3, 1020-1041

Abstract: This paper demonstrates that the ability of fund managers to create value depends on market liquidity conditions, which in turn introduces a liquidity risk exposure (beta) for skilled managers. We document an annual liquidity beta performance spread of 4% in the cross section of mutual funds over the period 1983–2014. Liquidity risk premia explain an insubstantial fraction of this spread; instead, the spread can be attributed to the differential ability of high liquidity beta funds to outperform across high and low market liquidity states, due to a differential rate of either mispricing correction or intensity of informed trading. Tests based on mispricing, proxied by a comprehensive set of 68 anomalies, and tick-by-tick trades, from a large proprietary institutional trading data set, corroborate the contribution of these channels. The results highlight the interaction between informed investors, mispricing, and liquidity beta.

Keywords: liquidity risk; mutual funds; active management; mispricing; investment skill; anomaly (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (21)

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