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Do Hedge Funds Profit From Mutual-Fund Distress?

  • Joseph Chen
  • Samuel Hanson
  • Harrison Hong
  • Jeremy C. Stein

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.

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File URL: http://www.nber.org/papers/w13786.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13786.

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Date of creation: Feb 2008
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Handle: RePEc:nbr:nberwo:13786
Note: CF PR AP
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