Did Connected Hedge Funds Benefit From Bank Bailouts During the Financial Crisis?

Abstract

We examine whether connected hedge funds (i.e. those that are prime-brokerage clients of bailout banks) benefited from bailout programs initiated in seven countries during the 2007–2009 financial crisis. We find that being connected to a bailout bank is generally beneficial for hedge funds in that it lowers the rate of fund failure. However, this benefit becomes smaller during the post bailout period, for example, due to the greater risk-taking and higher leverage of such funds subsequent to bailouts. As such, our findings provide support for the moral hazard hypothesis.

Keywords: Financial crisis, Hedge funds, Bank bailouts, Liquidation, Capital adequacy, Risk

JEL Classification: G10, G21, G23, G28