TY - JOUR
T1 - Hedge funds and stock price formation
AU - Cao, Charles
AU - Chen, Yong
AU - Goetzmann, William N.
AU - Liang, Bing
N1 - Publisher Copyright:
© 2018 CFA Institute. All rights reserved.
PY - 2018
Y1 - 2018
N2 - Using comprehensive quarterly data on hedge fund stock holdings, we study the role of hedge funds in the process of stock price formation. We find that hedge funds tend to hold undervalued stocks and that both hedge fund ownership and trading by hedge funds are positively related to the degree of stock mispricing. A portfolio of undervalued stocks with high hedge fund ownership generated a risk-adjusted return of 0.40% per month (4.8% annually), and the profit remained even after transaction costs. Hedge fund ownership and trades also precede the dissipation of stock mispricing. These patterns are either nonexistent or much weaker for other institutional investors. Our results suggest that hedge funds exploit and help correct mispricing but the process is not instantaneous.
AB - Using comprehensive quarterly data on hedge fund stock holdings, we study the role of hedge funds in the process of stock price formation. We find that hedge funds tend to hold undervalued stocks and that both hedge fund ownership and trading by hedge funds are positively related to the degree of stock mispricing. A portfolio of undervalued stocks with high hedge fund ownership generated a risk-adjusted return of 0.40% per month (4.8% annually), and the profit remained even after transaction costs. Hedge fund ownership and trades also precede the dissipation of stock mispricing. These patterns are either nonexistent or much weaker for other institutional investors. Our results suggest that hedge funds exploit and help correct mispricing but the process is not instantaneous.
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U2 - 10.2469/faj.v74.n3.4
DO - 10.2469/faj.v74.n3.4
M3 - Article
AN - SCOPUS:85052648400
SN - 0015-198X
VL - 74
SP - 54
EP - 68
JO - Financial Analysts Journal
JF - Financial Analysts Journal
IS - 3
ER -