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Book cover: Research in Finance

Research in Finance

ISSN: 0196-3821
Series editor(s): Professor John Kensinger

Subject Area: Accounting and Finance

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On Estimating the Failure Probability of Hedge Funds

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Title:On Estimating the Failure Probability of Hedge Funds
Author(s):Kajal Lahiri, Hany A. Shawky, Yongchen Zhao
Volume:27 Editor(s): John W. Kensinger ISBN: 978-0-85724-541-0 eISBN: 978-0-85724-542-7
Citation:Kajal Lahiri, Hany A. Shawky, Yongchen Zhao (2011), On Estimating the Failure Probability of Hedge Funds, in John W. Kensinger (ed.) Research in Finance (Research in Finance, Volume 27), Emerald Group Publishing Limited, pp.85-119
DOI:10.1108/S0196-3821(2011)0000027005 (Permanent URL)
Publisher:Emerald Group Publishing Limited
Article type:Chapter Item
Abstract:The main purpose of this chapter is to estimate a model for hedge fund returns that will endogenously generate failure probabilities using panel data where sample attrition due to fund failures is a dominant feature. We use the Lipper (TASS) hedge fund database, which includes all live and defunct hedge funds over the period January 1994 through March 2009, to estimate failure probabilities for hedge funds. Our results show that hedge fund failure prediction can be substantially improved by accounting for selectivity bias caused by censoring in the sample. After controlling for failure risk, we find that capital flow, lockup period, redemption notice period, and fund age are significant factors in explaining hedge fund returns. We also show that for an average hedge fund, failure risk increases substantially with age. Surprisingly, a 5-year-old fund on average has only a 65% survival rate.

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