TY - JOUR T1 - The Joint Dynamics of Hedge Fund Returns,<br/>Illiquidity, and Volatility JF - The Journal of Alternative Investments SP - 43 LP - 67 DO - 10.3905/jai.2012.15.1.043 VL - 15 IS - 1 AU - Jan Wrampelmeyer Y1 - 2012/06/30 UR - https://pm-research.com/content/15/1/43.abstract N2 - Hedge funds are frequently blamed for increasing volatility and illiquidity in financial markets. The author investigates the validity of this hypothesis by modeling the joint dynamics of hedge fund returns and volatility as well as illiquidity in the equity and the foreign exchange (FX) market. The results show that hedge funds tend to profit from periods of low equity liquidity but react negatively to shocks in volatility and FX illiquidity, indicating a significant FX exposure for many strategies. The author finds only weak evidence that hedge funds’ speculative trading causes higher volatility in financial markets. However, the perceived detrimental effect of hedge fund activity on financial markets can be explained by exposure to (alternative) risk factors which are correlated to volatility and illiquidity. Finally, there exist cross-market dynamics and bidirectional spillovers between volatility and illiquidity in the equity and FX market. These results have important implications for performance attribution and risk management, as well as regulatory policy.TOPICS: Real assets/alternative investments/private equity, factors, risk premia, currency, performance measurement ER -