Hedge Fund Stock Trading in the Financial Crisis of 2007–2009

Abstract

We study hedge fund trading in the stock market during the financial crisis of 2007-2008 and the surrounding years. We find that in the two quarters around the Lehman collapse (2008Q3-Q4) hedge funds reduced their equity holdings by about 29%, with nearly every fourth hedge fund cutting more than 40% of its equity portfolio in each quarter. We identify two main drivers of this behavior. First, in line with the presence of severe funding constraints, investor withdrawals and lender pressure account for about 78% of equity selloffs. These constraints are more binding for funds with low restrictions on investors' liquidity, and funds with low bargaining power vis-à-vis their brokers. Second, it appears that hedge funds reallocate capital to either cash, in an attempt to time the stock market, or other markets, in pursuit of more profitable investment opportunities. Finally, we find evidence for flight to quality (selloffs of high-volatility stocks) and static liquidity management (selloffs of high-liquidity stocks), which are consistent with distress selling driven by funding constraints.

Hedge Fund Crowds and Mispricing

“…Between 2001 and 2005, Thomson Reuters provided five classification updates. From September 2006 through December 2011, Thomson Reuters provided investor type updates every 2 See, for example, Brunnermeier and Nagel (2004), Griffin and Xu (2009), Blume and Keim (2011), Boyson et al (2011), Ben-David et al (2012), and Agarwal et al (2013a, b). 3 From the perspective of examining crowded portfolios, this is a positive attribute because we are interested in whether different managers make the same decisions, rather than whether a given manager makes the same decision for multiple funds they control (e.g., an offshore fund and its twin onshore fund).…”

“…3 From the perspective of examining crowded portfolios, this is a positive attribute because we are interested in whether different managers make the same decisions, rather than whether a given manager makes the same decision for multiple funds they control (e.g., an offshore fund and its twin onshore fund). 4 As noted by Ben-David et al (2012), Thomson Reuters has a longlasting relation with the U.S. Securities and Exchange Commission with respect to institutional filings (dating back to pre-Internet times) and extensive information about these institutions and their staff. To the best of our knowledge, Thomson Reuters has not provided this data set to other academics.…”

Selectivity and timing performance of UK investment trusts

“…The sample period spans the full global financial crisis period, beginning with the Quant Meltdown in the summer of 2007 and ends with the trough of the stock market in March 2009 (see, Ben-David et al, 2012). 13 A total of 505 observations in a two-year window from 1 July 2009 to 30 June 2011 are used for the out-of-sample test.…”

Mutual fund herding in response to hedge fund herding and the impacts on stock prices

“…Aragon and Strahan (2012) show that in the midst of the crisis, hedge funds' clients withdraw funds out of the fear for fund failures. Ben-David et al (2012) provide evidence that hedge funds engage in intense equity sell-offs because of the redemption demands. Mutual funds also face similar redemption pressures.…”