The Downside of High Water Marks: An Empirical Study

Journal of Investment Management (JOIM), Second Quarter 2012

Posted: 2 Jun 2012

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: June 1, 2012

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, highwater marks, hedge fund performance

JEL Classification: G00

Suggested Citation

Ray, Sugata, The Downside of High Water Marks: An Empirical Study (June 1, 2012). Journal of Investment Management (JOIM), Second Quarter 2012, Available at SSRN: https://ssrn.com/abstract=2072676

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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