Hedge Fund Holdings and Stock Market Efficiency
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Hedge Fund Holdings and Stock Market Efficiency Charles Cao
Smeal College of Business, Pennsylvania State University
Isenberg School of Management, University of Massachusetts
Andrew W. Lo
Sloan School of Management, Massachusetts Institute of Technology AlphaSimplex Group, LLC
Board of Governors of the Federal Reserve System
We study the relation between hedge fund equity holdings and measures of informational efficiency of stock prices derived from intraday transactions as well as daily data. Our findings support the role of hedge funds as arbitrageurs who reduce mispricing in the market. Hedge funds invest in stocks that are relatively inefficiently priced, and the price efficiency of these stocks improves after hedge funds increase their holdings. Hedge fund ownership contributes more to efficient pricing than ownership by other types of institu- tional investors. However, stocks held by hedge funds experienced large declines in price efficiency during several liquidity crises. (JEL G14, G23)
Received July 27, 2016; editorial decision January 07, 2017 by Editor Wayne Ferson.
Hedge fund ownership of stocks has increased rapidly over the past two decades, in particular prior to the outbreak of the Financial Crisis in 2008.
* We thank an anonymous referee, Reena Aggarwal, Vikas Agarwal, Turan Bali, Stephen Brown, Yong Chen, Jess Cornaggia, Burcu Duygan-Bump, Raphael Douady, Matt Eichner, Jesse Ellis, Wayne Ferson (the Editor), Campbell Harvey, Jean Helwege, David Hirshleifer, Tom King, Chris Schwarz, Nitish Sinha, Jeremy Stein, Zheng Sun, Sheridan Titman, Tugkan Tuzun, Ashley Wang, Jie Yang, Lu Zheng, and seminar and conference participants at the Federal Reserve Board of Governors, Bentley University, Georgetown University, University of Georgia, Imperial College London, North Carolina State University, Texas A&M, UC Irvine, University of Cambridge, University of Connecticut, University of Massachusetts Amherst, University of Melbourne, University of Miami, University of New South Wales, University of Sydney, University of Technology Sydney, University of Warwick, and the 2014 China International Conference in Finance, 2015 AFA Annual Meeting, and 7th Annual Hedge Fund Research Conference in Paris for their valuable comments and suggestions. We thank George Aragon and Philip Strahan for sharing their data on holdings of Lehman-connected funds, and Edward Atkinson and Grant Farnsworth for their excellent research assistance. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff of the Board of Governors, MIT, AlphaSimplex Group, or any of its affiliates and employees. Send correspondence to Lubomir Petrasek, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue N.W., Washington, D.C. 20551, USA, phone: 814-321-7810, email: firstname.lastname@example.org.
Published by Oxford University Press on behalf of The Society for Financial Studies 2017. This work is written by a US Government employee and is in the public domain in the US.
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