Sensation Seeking and Hedge Funds

Abstract

We show that, motivated by sensation seeking, hedge fund managers who own powerful sports cars take on more investment risk but do not deliver higher returns, resulting in lower Sharpe ratios, information ratios, and alphas. Moreover, sensation‐seeking managers trade more frequently, actively, and unconventionally, and prefer lottery‐like stocks. We show further that some investors are themselves susceptible to sensation seeking and that sensation‐seeking investors fuel the demand for sensation‐seeking managers. While investors perceive sensation seekers to be less competent, they do not fully appreciate the superior investment skills of sensation‐avoiding fund managers.

Do Alpha Males Deliver Alpha? Testosterone and Hedge Funds

“…These results suggest that high-testosterone managers may be more predisposed to fraud (Dimmock and Gerken, 2012). We show also that, unlike the sensation seekers studied in Brown et al (2018), high-testosterone managers do not take on more financial risk.…”

“…We then construct, for this subsample of funds, a sports car indicator variable that takes a value of one if a manager in the fund purchased a sports car, and a value of zero otherwise. Brown et al (2018) argue that sensation seekers are more likely 27 We find that high-and low-testosterone managers are on average 43.4 and 42.8 years old, respectively. The biological age di↵erence is statistically indistinguishable from zero at the ten percent level.…”

“…The results reported in Table A1 of the Internet Appendix indicate that unlike the sensation seekers studied in Brown et al (2018), high-testosterone hedge fund managers do not take on more risk. The coe cient estimates on FWHR are statistically indistinguishable from zero at the ten percent level for all measures of risk.…”

“…In our work, we carefully consider several alternative explanations, including sample selection, marital status (Love, 2010;Roussanov and Savor, 2014), biological age, sensation seeking (Grinblatt and Keloharju, 2009;Brown et al, 2018), barriers to entry, and fund management company e↵ects, but find that they are unlikely to drive our findings. Still, it is not possible to fully rule out all other stories or mechanisms.…”

“…Work on hedge fund operational risk has focused on assessing operational risk and its impact (Brown et al, 2008;2012) or predicting hedge fund fraud, one instance of operational risk (Dimmock and Gerken, 2012;Bollen and Pool, 2012). An exception is Brown et al (2018) who find that sensation seeking can have operational risk implications. We show that testosterone may be another basis for operational risk in hedge funds.…”