Monetary Policy and Hedge Funds' Reaching for Beta

Abstract

We uncover that hedge funds adjust their exposure to the equity market in response to monetary policy. Hedge funds decrease (increase) their exposure to the equity market following expansionary (contractionary) monetary policy in the previous month. Hedge funds with stronger response to monetary policy have higher gross and risk-adjusted returns. Hedge funds with higher measures of skills react to monetary policy more strongly. We explain these findings using the Fed Information Effect channel of government communication and rule out some other explanations: Hedge funds utilize the information in the FOMC announcements to update their predictions about the future of the market.

Keywords: Reaching for Beta, Fed Information Effect, Monetary Policy Transmission, Institutional Trading, Hedge Funds

JEL Classification: G10, G12, E44, E52