Share restrictions and asset pricing: Evidence from the hedge fund industry

This paper finds a positive, concave relation between the returns and share re-strictions of private investment funds, and shows that previously documented positive alphas can be interpreted as compensation for holding illiquid fund shares. The an-nual returns on funds with lockup provisions are approximately 4 % higher than those for non-lockup funds, and the alphas of funds with the most liquid shares are either negative or insignificant. This paper also finds a positive association between share restrictions and illiquidity in fund assets, suggesting that funds facing high redemption costs use restrictions to screen for investors with low-liquidity needs. The results are consistent with previous theories which posit that liquidity is priced, and that less liquid assets are held by investors with longer investment horizons. JEL classification: G11; G1