Working Paper: NBER ID: w13786
Authors: Joseph Chen; Samuel Hanson; Harrison Hong; Jeremy C. Stein
Abstract: This paper explores the question of whether hedge funds engage in front-running strategies that exploit the predictable trades of others. One potential opportunity for front-running arises when distressed mutual funds -- those suffering large outflows of assets under management -- are forced to sell stocks they own. We document two pieces of evidence that are consistent with hedge funds taking advantage of this opportunity. First, in the time series, the average returns of long/short equity hedge funds are significantly higher in those months when a larger fraction of the mutual-fund sector is in distress. Second, at the individual stock level, short interest rises in advance of sales by distressed mutual funds.
Keywords: Hedge Funds; Mutual Funds; Frontrunning; Market Distress
JEL Codes: G12; G20; G31; H0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mutual fund distress (G23) | hedge fund returns (G23) |
| mutual fund distress (G23) | short interest in individual stocks (G12) |
| hedge fund returns (G23) | mutual fund distress (G23) |