The Dodd-Frank Act and Hedge Fund Operational Risk

Abstract

We examine the impact of the post-Dodd-Frank change in 2011 on hedge fund disclosure. We find that new disclosure questions added to Form ADV improve the ability to forecast future adverse operational events compared to the information disclosed pre-Dodd-Frank. A byproduct of the analysis is a uni-dimensional operational risk score based on information from the SEC website. The measure is effective in predicting liquidation events, changes in leverage, and other performance metrics. It is also predictive of net fund flows, consistent with disclosed operational risk information being relevant to investor investment decisions. We find evidence that fund flow response increased significantly over a five-year period following the implementation of the amended Form ADV during the post-Dodd-Frank Act period.

Keywords: Operational Risk, Mandatory Disclosure, Hedge Funds, LASSO Regression, Information Asymmetry; Financial Regulation.

JEL Classification: G32, G28, G23