Hedge funds performance ratios adjusted to market liquidity risk1
Résumé
Market liquidity is complex to measure empirically. This explains why there is no consensus about performance ratios adjusted to its risk. We summarize market liquidity by two major characteristics: a costly one because of the loss of illiquidity premium; and a profitable one when investors can withdraw when they want. Then, in this paper, three new performance indicators are proposed to integrate, to a certain extent, market liquidity risk, especially for hedge funds investment: Liquidity-loss ratio will capture the cost characteristic whereas Liquidity-Sharpe ratio and Liquidity-profit ratio the profitable one. These new ratios try to be simple enough and also precise to help investors to choose between hedge funds strategies according to their liquidity profile: do they want to capture illiquidity risk premium? Do they want to be free to withdraw?
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