The economic consequences of hedge fund regulation: An analysis of the effect of the Dodd-Frank Act

Abstract

This paper exploits registration data administered by the Securities and Exchange Commission to examine the effect of the Dodd-Frank Act (the “DFA”) on profitability, risk-taking, and capital formation in the hedge fund industry. The data show that after the DFA was implemented, there was a significant decline in investor profitability – which can be at least partially attributed to direct compliance costs. However, compliance costs do not seem to fully explain the results: part of the decline seems to be driven by collateral effects of compliance, and particularly by diversion of managerial attention from core business activities and/or adjustments to financial valuation or reporting practices. The data also show that risk-taking did not change significantly, and that although fund managers closed funds and launched less funds in response to the law, that behavior did not result in less capital formation (in the form of assets under management).

JEL Classification: G23, G24, G28, K22