Search Results
Report
Performance maximization of actively managed funds
Ratios that indicate the statistical significance of a fund's alpha typically appraise its performance. A growing literature suggests that even in the absence of any ability to predict returns, holding options positions on the benchmark assets or trading frequently can significantly enhance performance ratios. This paper derives the performance-maximizing strategy--a variant of buy-write--and the least upper bound on such performance enhancement, thereby showing that if common equity indexes are used as benchmarks, the potential performance enhancement from trading frequently is usually ...
Discussion Paper
Bank-Intermediated Arbitrage
Since the 2007-09 financial crisis, the prices of closely related assets have shown persistent deviations—so-called basis spreads. Because such disparities create apparent profit opportunities, the question arises of why they are not arbitraged away. In a recent Staff Report, we argue that post-crisis changes to regulation and market structure have increased the costs to banks of participating in spread-narrowing trades, creating limits to arbitrage. In addition, although one might expect hedge funds to act as arbitrageurs, we find evidence that post-crisis regulation affects not only the ...
Journal Article
The truth about hedge funds
Do hedge funds help or hurt the financial markets in which they operate? The highly publicized troubles of Long Term Capital Management have once again focused the attention of policymakers and the press on the hedge fund industry and the cry for its regulation. This Economic Commentary refutes some of the commonly held myths about hedge funds and examines the rationale for regulating them.
Discussion Paper
How Has Post-Crisis Banking Regulation Affected Hedge Funds and Prime Brokers?
“Arbitrageurs” such as hedge funds play a key role in the efficiency of financial markets. They compare closely related assets, then buy the relatively cheap one and sell the relatively expensive one, thereby driving the prices of the assets closer together. For executing trades and other services, hedge funds rely on prime brokers and broker-dealers. In a previous Liberty Street Economics blog post, we argued that post-crisis changes to regulation and market structure have increased the costs of arbitrage activity, potentially contributing to the persistent deviations in the prices of ...
Journal Article
Hedging the risk
Working Paper
Fundamental Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data
We exploit detailed transaction and position data for a sample of long-short equity hedge funds to study the trading activity of fundamental investors. We find that hedge funds exhibit skill in opening positions, but that they close their positions too early, thereby forgoing about a third of the trades’ potential profitability. We explain this behavior with the limits of arbitrage: hedge funds close positions early in order to reallocate their capital to more profitable investments and/or to accommodate tightened financial constraints. Consistent with this view, we document that hedge ...
Working Paper
Investor Concentration, Flows, and Cash Holdings : Evidence from Hedge Funds
We show that when only a few investors own a substantial portion of a hedge fund's net asset value, flow volatility increases because investors' exogenous, idiosyncratic liquidity shocks are not diversified away. Using confidential regulatory filings, we confirm that high investor concentration hedge funds experience more volatile flows. These hedge funds hold more cash and liquid assets, which help absorb large, unexpected outflows. Such funds have to pay a liquidity premium and generate lower risk-adjusted returns. Investor concentration does not affect flow-performance sensitivity. These ...
Working Paper
Reputation and Investor Activism
We show that an activist's reputation is a critical determinant of the success of their campaigns. We model reputation as target managers' belief about the activist's willingness to initiate a proxy fight. Our model indicates reputation, rather than stake size, induces managers to settle without a proxy fight. We present empirical evidence supporting our model's predictions: target companies more-frequently increase payouts, change management or board composition, engage in a merger or acquisition, or otherwise reorganize in response to high reputation activist campaigns, while target actions ...