82 Pages Posted: 11 Mar 2011 Last revised: 14 May 2013
Date Written: December 20, 2012
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.
Keywords: idiosyncratic risk, hedge funds
Suggested Citation: Suggested Citation
Kang, Namho and Kondor, Peter and Sadka, Ronnie, Do Hedge Funds Reduce Idiosyncratic Risk? (December 20, 2012). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1782800 or http://dx.doi.org/10.2139/ssrn.1782800
By Andrew Ang