A Screen for Fraudulent Return Smoothing in the Hedge Fund Industry

51 Pages Posted: 18 Mar 2005  

Nicolas P. B. Bollen

Vanderbilt University - Finance

Veronika Krepely Pool

Indiana University - Kelley School of Business - Department of Finance

Date Written: January 2006

Abstract

This paper constructs a statistical screen for fraudulent return smoothing in the hedge fund industry. We show that if true returns are independently distributed, and a manager fully reports gains but delays reporting losses, then reported hedge fund returns will feature conditional serial correlation. Simulation evidence indicates that the power of the screen is restricted by the limited histories of some funds, but may still be sufficient to deter fraudulent return smoothing. Empirical evidence shows that the probability of observing conditional serial correlation is related to the volatility and magnitude of investor cash flows, consistent with managerial smoothing in response to the risk of capital flight.

Keywords: Hedge funds, fraud

JEL Classification: G23, G28

Suggested Citation

Bollen, Nicolas P. B. and Pool, Veronika Krepely, A Screen for Fraudulent Return Smoothing in the Hedge Fund Industry (January 2006). Available at SSRN: https://ssrn.com/abstract=686137 or http://dx.doi.org/10.2139/ssrn.686137

Nicolas P.B. Bollen (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

HOME PAGE: http://mba.vanderbilt.edu/faculty/nbollen.cfm

Veronika Krepely Pool

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

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