Chasing Absolute Returns: A Tale of Feedback Trading by Hedge Funds
49 Pages Posted: 20 Feb 2011 Last revised: 1 Feb 2016
Date Written: December 8, 2011
This paper studies the extent of feedback trading at the style level by hedge funds from both a positive and a normative perspective. We show that hedge funds continuously adjust their exposure to different risk factors conditional on the recent performance of these styles. The majority of funds apply a positive feedback strategy, whereas the remaining funds use a negative feedback strategy. This result is robust to the exact specification of the model and also holds out-of-sample. Fund managers do not adjust their exposures in anticipation of future performance; they have limited style timing ability. Finally, we show that positive feedback trading is indeed beneficial to fund performance. If managers could apply the positive feedback strategy more aggressively, however, they would benefit more from it.
Keywords: hedge funds, style analysis, feedback trading, time variation
JEL Classification: G11, G23
Suggested Citation: Suggested Citation