Do Hedge Funds Ride Market Irrationality?

62 Pages Posted: 12 Apr 2018 Last revised: 23 Feb 2019

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

We document empirical evidence that hedge funds temporarily ride rather than attack high market irrationality but they neither ride irrationality in long run nor ride during low irrationality periods. Irrationality-riding funds outperform irrationality-attacking funds by 4.4% per year on a risk-adjusted basis. The outperformance should be attributed to funds’ irrationality-riding strategy during the formation period of the tech bubble, and the bursting period of the housing bubble. The findings are consistent with the behavioral theories that sophisticated investors ride rather than attack unsophisticated investors’ strong misperception. Finally, we do not find that mutual funds have irrationality-riding ability.

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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