Fundamental Arbitrage Under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

50 Pages Posted: 30 Jun 2021

See all articles by Sandro Lunghi

Sandro Lunghi

Inalytics Limited

Daniel Schmidt

HEC Paris - Finance Department

Bastian von Beschwitz

Board of Governors of the Federal Reserve System

Date Written: March, 2021

Abstract

We exploit detailed transaction and position data for a sample of long-short equity hedge funds to study the trading activity of fundamental investors. We find that hedge funds exhibit skill in opening positions, but that they close their positions too early, thereby forgoing about a third of the trades’ potential profitability. We explain this behavior with the limits of arbitrage: hedge funds close positions early in order to reallocate their capital to more profitable investments and/or to accommodate tightened financial constraints. Consistent with this view, we document that hedge funds leave more money on the table after opening new positions, negative returns, or increases in funding constraints and volatility.

JEL Classification: G11, G12, G14, G15

Suggested Citation

Lunghi, Sandro and Schmidt, Daniel and von Beschwitz, Bastian, Fundamental Arbitrage Under the Microscope: Evidence from Detailed Hedge Fund Transaction Data (March, 2021). FEDS Working Paper No. 2021-22, Available at SSRN: https://ssrn.com/abstract=3873115 or http://dx.doi.org/10.17016/FEDS.2021.022

Sandro Lunghi (Contact Author)

Inalytics Limited ( email )

Croydon
United Kingdom

Daniel Schmidt

HEC Paris - Finance Department ( email )

France
0652678597 (Phone)

HOME PAGE: http://daniel-schmidt.eu

Bastian Von Beschwitz

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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