The Vocabulary of Hedge Funds

Abstract

Evidence from linguistics relates lexical diversity, i.e., the propensity of the writer to employ rich vocabulary, to cognitive ability. We find that lexically diverse hedge funds outperform lexically homogeneous hedge funds after adjusting for risk. Lexically diverse funds outperform by exploiting textual changes in corporate disclosures and harnessing qualitative information about firm manager's decisions. Data on sibling fund lexical diversity together with an instrumental variable approach and regressions address endogeneity concerns. Investors react correctly but not fully to the information on fund manager skill embedded in lexical diversity. Our results support the notion that linguistic skills are helpful for investment performance.

Keywords: hedge funds, textual analysis, lexical diversity, vocabulary, linguistic skills, corporate disclosures, cognitive ability, lexical richness

JEL Classification: G23