Critical Finance Review > Vol 11 > Issue 3-4

High Funding Risk and Low Hedge Fund Returns

Sven Klingler, Department of Finance, BI Norwegian Business School, Norway,
Suggested Citation
Sven Klingler (2022), "High Funding Risk and Low Hedge Fund Returns", Critical Finance Review: Vol. 11: No. 3-4, pp 505-539.

Publication Date: 10 Aug 2022
© 2022 S. Klingler
Funding riskHedge fundsInterbank riskLiborLiquidity


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In this article:
1. Background and Hypotheses 
2. The Data 
3. Empirical Evidence 
4. Robustness 
5. Conclusion 


I show that hedge funds with a high exposure to market-wide funding shocks—measured by changes in Libor-OIS spreads—subsequently underperform funds with a low exposure to market-wide funding shocks by 5.76% annually on a risk-adjusted basis (t = 4.04). To explain this puzzling result, I hypothesize that this type of funding risk exposure is connected to hedge funds’ liabilities with limited upside in normal times and severe downside risk during funding crises. Supporting this hypothesis, the performance difference between low-funding-risk and high-funding-risk funds is largest when funding constraints are most binding and for funds with more fragile liabilities.