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Short Selling Risk and Hedge Fund Performance 2019

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The goal of this project is to identify the large hedge funds that are short selling, and what exactly they are short selling. GME is a prime example of how you can take advantage of shorts.

Publication Title | Short Selling Risk and Hedge Fund Performance 2019

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Short Selling Risk and Hedge Fund Performance
Lei (Matthew) Ma* This Draft: December 2019
Abstract: Hedge funds, on average, outperform other actively managed funds. However, hedge fund managers often use trading strategies that are not used by other managed portfolios, and thus they bear unique risks. In particular, many hedge funds use short selling. I construct an option- based measure of short selling risk as the return spread between the decile of stocks with low option-implied short selling fees and the decile of those with high fees. I find that hedge funds that are significantly exposed to short selling risk outperform low-exposure funds by 0.45% per month on a risk-adjusted basis. However, there is no such relation for mutual funds that invest primarily on the long side. The results highlight that a significant proportion of abnormal performance of hedge funds is compensation for the risk they take on their short positions.
JEL classification: G23; G11
Keywords: hedge funds, mutual funds, short selling risk, short risk exposure
*Contact: Matthew Ma, Cox School of Business, Southern Methodist University, e-mail: leim@smu.edu; I am grateful to Jonathan Brogaard, Jeff Coles, Mike Cooper, Mike Gallmeyer, Pab Jotikasthira, Matthew Ringgenberg, Mehrdad Samadi, Steve Stubben, Kumar Venkataraman, Kelsey Wei, Ingrid Werner, Julie Wu, Feng Zhang, Feng Zhao, and conference and seminar participants at the University of Utah, the University of Texas at Dallas, and Northern Finance Association Conference 2018 for insightful and helpful comments. All remaining errors are my own.

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