Document Type


Date of Degree

Summer 2015

Degree Name

PhD (Doctor of Philosophy)

Degree In

Business Administration

First Advisor

Jay Sa-Aadu

Second Advisor

Ashish Tiwari


This thesis consists of three chapters and investigates the issues related to liquidity risk, credit market contagion, and corporate cash holdings. The first chapter is coauthored work with Professor Jay Sa-Aadu and Associate Professor Ashish Tiwari and is titled ‘Market Liquidity, Funding Liquidity, and Hedge Fund Performance.’ The second chapter is sole-authored and is titled ‘Credit Market Contagion and Liquidity Shocks.’ The third chapter is coauthored with Steven Savoy and titled ‘Ambiguity Aversion and Corporate Cash Holdings.’

The first chapter examines the interaction between hedge funds’ performance and their market liquidity risk and funding liquidity risk. Using a 2-state Markov regime switching model we identify regimes with low and high market-wide liquidity. While funds with high market liquidity risk exposures earn a premium in the high liquidity regime, this premium vanishes in the low liquidity states. Moreover, funding liquidity risk, measured by the sensitivity of a hedge fund’s return to the Treasury-Eurodollar (TED) spread, is an important determinant of fund performance. Hedge funds with high loadings on the TED spread underperform low-loading funds by about 0.49% (10.98%) annually in the high (low) liquidity regime, during 1994-2012.

The second chapter provides evidence on credit market contagion using CDS index data and identifies the channels through which contagion propagates in credit markets. The results show that funding liquidity and market liquidity are significant channels of contagion during periods with widening credit spreads and adverse liquidity shocks. These results provide support for the theoretical model proposed by Brunnermeier and Pedersen (2009) according to which negative liquidity spirals can lead to contagion across various asset classes. Furthermore, during periods with tightening credit spreads and positive liquidity shocks, the results indicate that a prime broker index and a bank index are important channels contributing to co-movement in credit spreads. This suggests that financial intermediaries play an important role in spreading market rallies across credit markets.

The third chapter investigates the link between investors’ ambiguity aversion and precautionary corporate cash holdings. Investors’ ambiguity aversion is measured by the proportion of individual investors in a firm’s investor base who are hypothesized to be more ambiguity averse compared to institutional investors. We show that the value of cash holdings is negatively associated with the extent of ambiguity aversion in a firm’s shareholder base for firms that are financially constrained. Our results also show that financially constrained firms with a higher proportion of ambiguity averse investors hold less cash. These results provide support for models in which ambiguity averse investors dislike the cash holdings of firms, that are held for precautionary reasons to fund long term projects, given that the returns on long term projects are ambiguous.

Public Abstract

In this dissertation I explore the controversial issues related to liquidity risk, credit market contagion, and corporate cash holdings. The economic crisis of 2008 provided a dramatic illustration of the importance of liquidity and the risk of contagion in the economy. Researchers and practitioners have been studying the recent crisis to better understand the implications of such risks to avoid similar events in the future.

In the first chapter, we examine the interaction between hedge funds’ performance and their market liquidity risk and funding liquidity risk. In normal circumstances, investors earn a premium by having exposure to market liquidity. We show that this premium vanishes during low market liquidity periods. Our results also show that funding liquidity is an important factor in hedge fund performance.

The second chapter explores the issues around financial contagion in credit markets. The recent crisis of 2008 started in the sub-prime mortgage market and extended to the whole economy. I provide evidence on the existence of contagion in U.S. credit markets and determine the channels through which the contagion propagates. My results show that liquidity is an important channel for contagion in credit markets.

The third chapter examines the cash holdings held by U.S. corporations. Cash holdings of U.S. companies have grown enormously in the recent decades. We explain this phenomenon from the perspective of investors. Our results show that firms with high level of ambiguity averse investors, or retail investors, hold less cash. We attribute the difference to the relatively higher ambiguity aversion of retail investors compared to institutional investors.


publicabstract, Ambiguity Aversion, Corporate Cash Holdings, Credit Markets, Financial Contagion, Hedge Funds, Liquidity risk


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Copyright 2015 Mahmut Ilerisoy