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Limits of Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

Author

Listed:
  • Bastian von Beschwitz

    (Boards of Governors of the Federal Reserve System)

  • Schmidt Daniel

    (HEC Paris - Ecole des Hautes Etudes Commerciales)

Abstract

We exploit detailed transaction and position data for a sample of long-short equity hedge funds to document new facts about the trading activity of sophisticated investors. We find that the initiation of both long and short positions is associated with significant abnormal returns, suggesting that the hedge funds in our sample possess investment skill. In contrast, the closing of long and short positions is followed by return continuation, implying that hedge funds close their positions too early and "leave money on the table." As we demonstrate with a simple model, this behaviour can be explained by hedge funds being (risk) capital constrained and facing position monitoring costs. Consistent with our model, we document that the return continuation following closing orders is more pronounced when these constraints become more binding (e.g., after negative fund returns or increases in volatility).

Suggested Citation

  • Bastian von Beschwitz & Schmidt Daniel, 2017. "Limits of Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data," Working Papers hal-01970726, HAL.
    • Handle: RePEc:hal:wpaper:hal-01970726
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    Cited by:

    1. Vikas Agarwal & Stefan Ruenzi & Florian Weigert, 2018. "Unobserved Performance of Hedge Funds," Working Papers on Finance 1825, University of St. Gallen, School of Finance.
    2. Antonio Gargano & Juan Sotes-Paladino & Patrick Verwijmeren, 2022. "Out of Sync: Dispersed Short Selling and the Correction of Mispricing," Working Papers 108, Red Nacional de Investigadores en Economía (RedNIE).

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