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Do Hedge Funds Reduce Idiosyncratic Risk?Namho KangUniversity of Connecticut Peter KondorLondon School of Economics & Political Science (LSE); Central European University (CEU) Ronnie SadkaBoston College - Carroll School of Management December 20, 2012 Journal of Financial and Quantitative Analysis (JFQA), Forthcoming Abstract: This paper studies the effect of hedge-fund trading on idiosyncratic risk. We hypothesize that while hedge-fund activity would often reduce idiosyncratic risk, high initial levels of idiosyncratic risk might be further amplified due to fund loss limits. Panel-regression analyses provide supporting evidence for this hypothesis. The results are robust to sample selection and are further corroborated by a natural experiment using the Lehman bankruptcy as an exogenous adverse shock to hedge-fund trading. Hedge-fund capital also explains the increased idiosyncratic volatility of high-idiosyncratic-volatility stocks as well as the decreased idiosyncratic volatility of low-idiosyncratic-volatility stocks over the past few decade.
Number of Pages in PDF File: 82 Keywords: idiosyncratic risk, hedge funds Date posted: March 11, 2011 ; Last revised: May 14, 2013Suggested CitationContact Information
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