Hedge Funds and Equity Prices

Abstract

This article analyzes hedge funds’ expansion during 2000–09 and its implications for stock returns. Hedge funds more than doubled their equity ownership prior to the 2007–09 financial crisis. In this expansion period, their trading predicts increasing one-quarter-ahead stock returns and return reversals in the 2nd year. These reversals stem from the expansion of mature funds, while young funds’ trading predicts one-quarter-ahead returns without future reversals. The above price pressures disappear when hedge funds shift to contractions in the financial crisis. These findings are consistent with mature funds’ expansions exerting pressures on equities and young funds possessing stock picking skills.