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Sentiment hedging: How hedge funds adjust their exposure to market sentiment

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  • Zheng, Yao
  • Osmer, Eric
  • Zhang, Ruiyi

Abstract

We investigate a new facet of hedging ability among hedge fund managers. Using a sentiment exposure model, we find evidence that fund managers adjust the market exposure of their portfolios to changes in market sentiment. Out-of-sample evidence indicates that hedge funds having the highest negative sentiment exposure outperform funds having the highest positive sentiment exposure by 1.7%–2.4% per year. The results remain persistent for both the sub-period analysis and the analysis excluding crisis periods. We also find that a hedge fund's willingness to take on sentiment exposure decreases with fund age and fund size and increases with incentive fees. Our findings remain robust even after controlling for hedge fund data biases, as well as using alternative sentiment measures.

Suggested Citation

  • Zheng, Yao & Osmer, Eric & Zhang, Ruiyi, 2018. "Sentiment hedging: How hedge funds adjust their exposure to market sentiment," Journal of Banking & Finance, Elsevier, vol. 88(C), pages 147-160.
    • Handle: RePEc:eee:jbfina:v:88:y:2018:i:c:p:147-160
    DOI: 10.1016/j.jbankfin.2017.11.016
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    8. Soumaya Ben Khelife & Christian Urom & Khaled Guesmi & Ramzi Benkraiem, 2022. "American hedge funds industry, market timing and COVID-19 crisis," Journal of Asset Management, Palgrave Macmillan, vol. 23(5), pages 390-399, September.
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    10. Yao Zheng & Eric Osmer & Liancun Zheng, 2020. "Can mutual funds time investor sentiment?," Review of Quantitative Finance and Accounting, Springer, vol. 54(4), pages 1449-1486, May.
    11. Zheng, Yao & Osmer, Eric & Zheng, Liancun, 2021. "Can mutual fund managers time commonality in stock market misvaluation?," Journal of Economics and Business, Elsevier, vol. 117(C).
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    More about this item

    Keywords

    Hedge funds; Market sentiment; Fund age; Fund size; Incentive fees;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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