DP10151 The Impact of Hedge Funds on Asset Markets

Author(s): Mathias Kruttli, Andrew J Patton, Tarun Ramadorai
Publication Date: September 2014
Keyword(s): bonds, currencies, equities, hedge funds, liquidity, return predictability
JEL(s): G11, G12, G14, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10151

This paper provides empirical evidence of the impact of hedge funds on asset markets. We construct a simple measure of the aggregate illiquidity of hedge fund portfolios, and show that it has strong in- and out-of-sample forecasting power for 72 portfolios of international equities, corporate bonds, and currencies over the 1994 to 2013 period. The forecasting ability of hedge fund illiquidity for asset returns is in most cases greater than, and provides independent information relative to, well-known predictive variables for each of these asset classes. We construct a simple equilibrium model based on liquidity provision by hedge funds to noise traders to rationalize our findings, and empirically verify auxiliary predictions of the model.