The Role of Hedge Funds in the Security Price Formation Process
Pennsylvania State University
Texas A&M University - Department of Finance
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
University of Massachusetts Amherst - Department of Finance & Operations Management; China Academy of Financial Research (CAFR)
August 25, 2013
We present evidence on the role of hedge funds in the price formation process by using data on hedge fund equity ownership. Compared to other institutional investors, hedge funds tend to hold stocks that plot above the security market plane (positive alpha stocks). Focusing on the set of stocks plotting above the security market plane, we find that, in the cross-section of stocks, hedge fund ownership and trading is positively related to the degree of mispricing and arbitrage costs. We also document that a change in hedge fund investment is informative about future stock returns over the horizon of one quarter. Overall, these findings suggest that hedge funds play an important role in reducing asset mispricing.
Number of Pages in PDF File: 60
Keywords: Hedge fund holdings, positive alpha stocks, alphas, arbitrage costs, investment value
JEL Classification: G11, G23working papers series
Date posted: August 2, 2012 ; Last revised: August 29, 2013
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