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How Would Hedge Fund Regulation Affect Investor Behavior? Implications for Systemic Risk

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  • Minamihashi, Naoaki
  • Wakamori, Naoki

Abstract

We estimate an investors’ demand model for hedge funds to analyze the potential impact of leverage limits in the industry. Our estimation results highlight the importance of heterogeneous investor preference for the use of leverage, i.e., 20% of investors prefer leverage usage while others do not. We then conduct a policy simulation in which regulators put a cap on allowable leverage, as proposed by the Financial Stability Board in 2012. Simulation results suggest that the 200% leverage limit would lower the total demand (assets under management) for hedge funds by 10%. In particular, the regulation would lead to lower investments in highly leveraged funds and to lower investments in risky strategies, which, in turn, would reduce systemic risk.

Suggested Citation

  • Minamihashi, Naoaki & Wakamori, Naoki, 2014. "How Would Hedge Fund Regulation Affect Investor Behavior? Implications for Systemic Risk," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 473, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    • Handle: RePEc:trf:wpaper:473
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    References listed on IDEAS

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    1. Aragon, George O. & Strahan, Philip E., 2012. "Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy," Journal of Financial Economics, Elsevier, vol. 103(3), pages 570-587.
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    5. Enrique Schroth, 2006. "Innovation, Differentiation, and the Choice of an Underwriter: Evidence from Equity-Linked Securities," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 1041-1080.
    6. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-890, July.
    7. Ferguson, R. & Laster, D., 2007. "Hedge funds and systemic risk," Financial Stability Review, Banque de France, issue 10, pages 45-54, April.
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    More about this item

    Keywords

    hedge funds; demand estimation; leverage; regulation; systemic risk;
    All these keywords.

    JEL classification:

    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • L52 - Industrial Organization - - Regulation and Industrial Policy - - - Industrial Policy; Sectoral Planning Methods

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