Managing hedge fund liquidity risks

Serge Darolles and Guillaume Roussellet
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Serge Darolles: DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique
Guillaume Roussellet: CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique, Centre de recherche de la Banque de France - Banque de France

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Abstract: Hedge fund optimal portfolios are studied in the presence of market and funding liquidity risks. We consider a two-period economy with a singlehedge fund. The fund has access to cash, which is available every period, and to an illiquid asset, which pays off only at the end of the secondperiod. Funding liquidity risk takes the form of a random proportion of the fund's assets under management being withdrawn by clients in periodone. The fund can then liquidate a part of the illiquid position by bidding on a secondary market where a random haircut on the effective sellingprice is applied. We solve the allocation problem of the fund and find its optimal portfolio. Whereas the cash buffer is monotonously decreasing inthe secondary market liquidity, we show that the fund's default probability is bell-shaped.

Date: 2017-12
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Published in 11th International Conference on Computational and Financial Econometrics (CFE 2017), Dec 2017, London, United Kingdom

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04590372

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