Conditional Return Smoothing in the Hedge Fund Industry

Conditional Return Smoothing in the Hedge Fund Industry

We show that if true returns are independently distributed and a manager fully reports gains but delays reporting losses, then reported returns will feature conditional serial correlation. We use conditional serial correlation as a measure of conditional return smoothing. We estimate conditional ser...

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Bibliographic Details
Published in:Journal of financial and quantitative analysis Vol. 43; no. 2; pp. 267 - 298
Main Authors: Bollen, Nicolas P. B., Pool, Veronika K.
Format: Journal Article
Language:English
Published: New York, USA Cambridge University Press 01-06-2008
University of Washington School of Business Administration, University of Utah David Eccles School of Business, and New York University Leonard N. Stern School of Business
Subjects:
Asset management
Correlation
Correlations
Data smoothing
Financial engineering
Fraud
Hedge funds
Investment returns
Investment strategies
Investment trusts
Investors
Mutual funds
Portfolio management
Quantitative analysis
Volatility
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Summary:We show that if true returns are independently distributed and a manager fully reports gains but delays reporting losses, then reported returns will feature conditional serial correlation. We use conditional serial correlation as a measure of conditional return smoothing. We estimate conditional serial correlation in a large sample of hedge funds. We find that the probability of observing conditional serial correlation is related to the volatility and magnitude of investor cash flows, consistent with conditional return smoothing in response to the risk of capital flight. We also present evidence that conditional serial correlation is a leading indicator of fraud.
Bibliography:Bollen, nick.bollen@owen.vanderbilt.edu, Owen Graduate School of Management, Vanderbilt University, 401 21st Ave S, Nashville, TN 37240; Pool, vkpool@indiana.edu, Kelley School of Business, Indiana University, 1309 East Tenth Street, Bloomington, IN 47405. The authors thank Stephen Brown (the editor), Mila Getmansky (the referee), George Aragon, Cliff Ball, Bill Christie, Greg Dyra, Yanqin Fan, Wayne Ferson, Joel Hasbrouck, David Hsieh, Ron Masulis, Steve Ross, John Van, and seminar participants at Louisiana State University, Vanderbilt University, and the UVA Conference on Probability, Financial Derivatives, and Asset Pricing for helpful comments and suggestions. The Dean's Fund for Research and the Financial Markets Research Center at the Owen Graduate School of Management, Vanderbilt University, provided generous research support.
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ArticleID:00352
PII:S0022109000003525
ark:/67375/6GQ-0JD6FZJK-F
ObjectType-Article-2
SourceType-Scholarly Journals-1
ObjectType-Feature-1
content type line 23
ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109000003525