Hedge Fund Ownership, Funding Liquidity Constraints and Excess Return Co-Movement
39 Pages Posted: 6 Sep 2016
Date Written: September 6, 2016
This paper examines the funding liquidity faced by hedge funds and the resulting implication for stocks’ excess return co-movement. We find that hedge fund ownership tends to induce a higher stocks’ return co-movement with each other, compared to other institutional investors like mutual funds and pension funds. By exploring our sample into different periods, we show that the effect of excess return co-movement is much stronger during tight funding periods, which is consistent with price pressure due to flow-induced correlated trading by hedge funds. We further develop the cross-stock reversal trading strategy proposed by Anton and Polk (2014) and find significant abnormal return if we use the portfolio return of connected stocks held in common by hedge funds as a confirming signal. In particular, this trading strategy exploiting such price pressure due to common hedge fund ownership delivers a monthly alpha of 0.3%, which reaches 1.5% over the periods of funding liquidity constraints.
Keywords: Hedge fund, Co-movement
JEL Classification: G12
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