BAFI Seminar - Bing Liang
The Role of Hedge Funds in the Security Price Formation Process
Speaker(s): Bing Liang - Univ. of Massachusetts
Date & Time: Friday, Oct. 2, 2015 from Noon to 1:30 p.m.
Using a comprehensive dataset of stock holdings by hedge funds, we empirically examine the role of hedge funds in the price formation process. We find that hedge funds tend to hold stocks plot above the security market plane, i.e., undervalued stocks. The sample of undervalued stocks provides a unique setting in which theory makes straightforward predictions about how arbitrageurs should trade and hold mispriced assets, and how their activities should predict future stock returns. In the cross-section of undervalued stocks, hedge fund ownership and trades are positively related to the degree of mispricing and arbitrage cost. A portfolio of undervalued stocks with high hedge fund ownership generates an out-of-sample risk-adjusted return of 0.48% per month, or 5.76% per year. Hedge fund ownership and trades also precede the dissipation of positive alpha. In contrast, all these patterns are either nonexistent or much weaker for non-hedge fund ownership. The findings are robust to alternative benchmark models and alternative misvaluation measures. Overall, our results suggest that hedge funds exploit and reduce stock mispricing.
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Attachment: Bing Liang paper