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Sentiment Risk, Sentiment Timing, and Hedge Fund Returns

61 Pages Posted: 14 Jan 2016  

Yong Chen

Texas A&M University - Department of Finance

Bing Han

University of Toronto, Rotman School of Management

Jing Pan

University of Utah - David Eccles School of Business

Date Written: January 12, 2016

Abstract

We examine whether exposure to sentiment risk helps explain the cross-sectional variation in hedge fund returns. We find that funds with sentiment beta in the top decile subsequently outperform those in the bottom decile by 0.67% per month on a risk-adjusted basis. Further, we show that some hedge funds have the ability to time sentiment by having high exposure to a sentiment factor when the factor premium is high, and sentiment timing also contributes to fund performance. Our results are robust to controlling for fund characteristics and other risk factors known to affect hedge fund returns and hold for alternative sentiment risk measures. Overall, these findings highlight sentiment risk as a source of limits to arbitrage faced by hedge funds.

Keywords: Hedge funds, sentiment risk, sentiment timing, alpha, limits to arbitrage

JEL Classification: G23, G11

Suggested Citation

Chen, Yong and Han, Bing and Pan, Jing, Sentiment Risk, Sentiment Timing, and Hedge Fund Returns (January 12, 2016). Mays Business School Research Paper No. 2714580; Rotman School of Management Working Paper No. 2714580. Available at SSRN: https://ssrn.com/abstract=2714580 or http://dx.doi.org/10.2139/ssrn.2714580

Yong Chen (Contact Author)

Texas A&M University - Department of Finance ( email )

360 Wehner Building
College Station, TX 77843-4218
United States

Bing Han

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Jing Pan

University of Utah - David Eccles School of Business ( email )

UT
United States

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