The Downside of High Water Marks: An Empirical Study

40 Pages Posted: 21 Sep 2009 Last revised: 25 May 2011

See all articles by Sugata Ray

Sugata Ray

University of Alabama - Department of Economics, Finance and Legal Studies

Multiple version iconThere are 2 versions of this paper

Date Written: March 22, 2011

Abstract

Using a large sample of hedge funds, I study the effects of the high water mark (HWM) on fund performance, risk, and fund closure. I find that as funds fall below the HWM, the standard deviation of future returns increases, the future expected Sharpe ratio decreases, and the incidence of fund closure increases. In addition to supporting predictions from models in the literature, these results resonate well with economic intuition: HWM contracts function as if the fund manager holds call options on the fund's returns which have varying degrees of moneyness depending on how far the fund is from the HWM.

Keywords: hedge funds, high water marks, hedge fund performance

JEL Classification: G11, G20, G23

Suggested Citation

Ray, Sugata, The Downside of High Water Marks: An Empirical Study (March 22, 2011). Available at SSRN: https://ssrn.com/abstract=1476372 or http://dx.doi.org/10.2139/ssrn.1476372

Sugata Ray (Contact Author)

University of Alabama - Department of Economics, Finance and Legal Studies ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States

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