Home Bias and Local Contagion: Evidence from Funds of Hedge Funds

Abstract

Our paper analyzes the geographical preferences of hedge fund investors and the implication of these preferences for hedge fund performance. We find that funds of hedge funds overweigh their investments in hedge funds located in the same geographical areas and that funds with a stronger local bias exhibit superior performance. This local bias also gives rise to excess flow comovement and extreme return clustering within geographic areas. Overall, our results suggest that while funds of funds benefit from local advantages, their local bias also creates market segmentation that can destabilize the underlying hedge funds.

Keywords: Hedge Funds, Funds of Funds, Home Bias, Informational Advantage, Contagion, Comovement

JEL Classification: G01, G11, G23