Limits to Arbitrage: Time-Varying Market Neutrality of Hedge Funds
21 Pages Posted: 11 Sep 2009
Date Written: August 18, 2009
Abstract
Little is known about the exact sources and risks of hedge fund’s market neutral strategies. Based on existing views on arbitrage trading, such as done by hedge funds, we formulate and test a hypothesis that market neutrality is affected by market-wide liquidity. We find that such is the case for equity-oriented hedge fund indices as well as portfolios sorted on stock market beta. Also, liquidity has a higher impact on neutrality in a smaller market such as the S&P MidCap and SmallCap. Contrary to our expectations, the relation between liquidity and market neutrality is stronger for portfolios with higher beta.
Keywords: hedge funds, market neutrality, liquidity
JEL Classification: G12, G2
Suggested Citation: Suggested Citation
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