Research On The Calibration Of Hedge Fund Liquidity Risk And Application

After the Long-term Capital Management collapsed in 1998, researchers pay more attention on the liquidity risk in Hedge Fund. The characteristic of Hedge Fund (complexity of investment,high leverage,privacy etc) has made the liquidity risk becoming the major risk source which is dangerous to the development of Hedge Fund.According to the different index, there are many kinds.of measurements to calibrate the liquidity risk. For example: Bid-ask Spread (Roll, 1984;Baghot, 1971), Market depth(Hasbrouck,1999), Price impact(Harris,1988),Immediacy(Longstaff,1995). Based on the models: BDSS, H-W, T-A, this paper use the VaR theory and choose the Bid-ask Spread and daily mean volume as the liquidity risk index to set up themodel:Liquidity adjusted Value at Risk(LaVaR). With this model, the author begins to research the Hedge Fund liquidity risk.Because of the Hedge Fund has the right to do not disclosure the information in public, we can not get the useful information on the portfolio and strategy of Hedge Fund. So the best way we can do is simulation. We choose two kinds of Hedge Fund as the objects: Stock Index Arbitrage Hedge Fund and Futures Management Hedge Fund.Stock Index Arbitrage Hedge Fund: the portfolio is composed of stocks and Hang Seng Index in Hong Kong. The strategy is Arbitrage.Futures Management Hedge Fund: the portfolio is composed of copper and fuel oil in Shanghai Futures Exchange and fuel oil spot in Singapore. The strategy is long position both in futures and spot to simulate the trend tracking.We use the GARCH to calculate the variance of return with GED distribution. The confidence level is 95%.The results shows: the model has a good accuracy, it can include most of the risk; liquidity risk has a significant proportion in risk, the ratio of exogenous liquidity risk and endogenous liquidity risk in Stock Index Arbitrage Hedge Fund is almost 4:1, in Futures Management Hedge Fund is almost is 1:1; compared to the VaR ,the requirement for capital amount in exogenous liquidity risk is not big, but for the endogenous liquidity risk, the capital amount is boosted.On the application of liquidity risk, we focus on the asset allocation model. The Black-Litterman model is created by Fisher Black and Robert Litterman of Goldman, Sachs & Company. Based on the market capitalization weights, the asset allocation is decided by incorporating the manager views. Furthermore, we add the liquidity risk as constraint variable to the B-L model. The result shows that if the asset owns a big liquidity risk, it would be a little weight in allocation. The relationship between liquidity risk and weight is negative direction; furthermore, the portfolio return will improve after considering liquidity risk. Actually it is the liquidity risk premium.