Do Hedge Funds Ride Market Irrationality?

63 Pages Posted: 12 Apr 2018 Last revised: 11 Sep 2020

See all articles by Bing Liang

Bing Liang

University of Massachusetts Amherst - Department of Finance

Huacheng Zhang

Southwestern University of Finance and Economics - Institute of Financial Studies

Date Written: August 1, 2017

Abstract

Utilizing a novel style identification procedure, we show that style-shifting is a dynamic strategy commonly employed by hedge fund managers. Three quarters of hedge funds shifted their investment styles at least once over the period from January 1994 to December 2013. We perform empirical tests of two hypotheses for the motivations of hedge fund style-shifting, namely backward-looking and forward-looking hypotheses. We find no evidence that style-shifting funds are backward-looking. Instead, we show evidence that managers of style-shifting funds exhibit both style-timing ability and the skill of generating abnormal returns in new styles. The new styles that hedge funds shift to on average outperform their old styles by 0.76% and style-shifting funds on average outperform their new style benchmark by 1.10% over the subsequent 12-month horizon. Finally, we show that small funds, winner funds, and funds with net inflows are more likely to shift styles.

Keywords: hedge funds, noise trader, irrationality riding, arbitrage

Suggested Citation

Liang, Bing and Zhang, Huacheng, Do Hedge Funds Ride Market Irrationality? (August 1, 2017). Available at SSRN: https://ssrn.com/abstract=3018483 or http://dx.doi.org/10.2139/ssrn.3018483

Bing Liang (Contact Author)

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States

Huacheng Zhang

Southwestern University of Finance and Economics - Institute of Financial Studies ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

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