Short Selling Risk and Hedge Fund Performance

52 Pages Posted: 5 Dec 2019

See all articles by Matthew Ma

Matthew Ma

Southern Illinois University at Carbondale

Date Written: October 31, 2019

Abstract

Hedge funds, on average, outperform other actively managed funds. However, hedge fund managers often use trading strategies that are not used by other managed portfolios, and thus they bear unique risks. In particular, many hedge funds use short selling. I construct an option-based measure of short selling risk as the return spread between the decile of stocks with low option-implied short selling fees and the decile of those with high fees. I find that hedge funds that are significantly exposed to short selling risk outperform low-exposure funds by 0.45% per month on a risk-adjusted basis. However, there is no such relation for mutual funds that invest primarily on the long side. The results highlight that a significant proportion of abnormal performance of hedge funds is compensation for the risk they take on their short positions.

Keywords: hedge funds, mutual funds, short selling risk, short risk exposure

JEL Classification: G23; G11

Suggested Citation

Ma, Matthew, Short Selling Risk and Hedge Fund Performance (October 31, 2019). Available at SSRN: https://ssrn.com/abstract=3490038 or http://dx.doi.org/10.2139/ssrn.3490038

Matthew Ma (Contact Author)

Southern Illinois University at Carbondale ( email )

Rehn Hall - Mail Code 4626
Carbondale, IL Illinois 62901-4515
United States

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