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Conditional Return Smoothing in the Hedge Fund Industry

53 Pages Posted: 17 Oct 2006  

Nicolas P. B. Bollen

Vanderbilt University - Finance

Veronika Krepely Pool

Indiana University - Kelley School of Business - Department of Finance

Abstract

We show that if true returns are independently distributed, and a manager fully reports gains but delays reporting losses, then reported returns will feature conditional serial correlation. We use conditional serial correlation as a measure of conditional return smoothing. We estimate conditional serial correlation in a large sample of hedge funds. We find that the probability of observing conditional serial correlation is related to the volatility and magnitude of investor cash flows, consistent with conditional return smoothing in response to the risk of capital flight. We also present evidence that conditional serial correlation is a leading indicator of fraud.

Keywords: Hedge funds, fraud

JEL Classification: G23, G28

Suggested Citation

Bollen, Nicolas P. B. and Pool, Veronika Krepely, Conditional Return Smoothing in the Hedge Fund Industry. Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=937990

Nicolas P.B. Bollen (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

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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