Survival of Hedge Funds : Frailty vs Contagion

We develop a new methodology to analyse the dynamics of liquidation risk dependence in the hedge funds industry. This dependence results either from a common exogenous factor, or from conta- gion phenomena caused by an endogenous behaviour of fund managers. Our empirical analysis shows that the common factor, the sensitivities to this factor and the contagion scheme can be interpreted in terms of liquidity risks. The factor is related nonlinearly to rollover and margin funding liquidity risks. The sensitivities to the factor are funding liquidity risk exposures, which depend on the redemption and leverage policies of fund managers. The causal scheme captures the reinforcing spiral between funding and market liquidity