Are Hedge Funds Systemically Important?

33 Pages Posted: 9 Oct 2010 Last revised: 17 Jan 2013

Gregory W. Brown

University of North Carolina (UNC) at Chapel Hill - Finance Area

Jeremiah Green

Pennsylvania State University

John R. M. Hand

University of North Carolina Kenan-Flagler Business School

Date Written: October 7, 2010

Abstract

Using a proprietary and unusually comprehensive database of hedge fund returns, we seek to identify abnormal performance consistent with opportunistic trading (e.g., bear raids) or synchronized actions (e.g., widespread forced liquidations) that could generate systemic risk. We find no evidence that hedge funds systematically benefit from opportunistic trading. In contrast, some funds operating with strategies that commonly utilize leverage (e.g., fixed income arbitrage and event-driven strategies) perform significantly worse than would be expected given ex ante risk-factor loadings. This suggests that forced liquidations probably caused some funds to sell into a falling market at fire sale prices. However, underperformance is not concentrated in specific funds that use leverage or during the height of the systemic risks in September 2008 indicating that selling pressure likely derives from meeting redemptions versus forced selling during the crisis. These results suggest new policies regulating hedge funds should focus on certain fund-level risks instead of strategy or industry risks.

Keywords: Financial Crisis, Hedge Funds, Systemic Risk, Short Selling, Derivatives

JEL Classification: G23

Suggested Citation

Brown, Gregory W. and Green, Jeremiah and Hand, John R. M., Are Hedge Funds Systemically Important? (October 7, 2010). Journal of Derivatives, Vol. 20, No. 2, 2012. Available at SSRN: https://ssrn.com/abstract=1689079 or http://dx.doi.org/10.2139/ssrn.1689079

Gregory W. Brown (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Jeremiah Green

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

John R. M. Hand

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3173 (Phone)
919-962-4727 (Fax)

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