The Behavior of Hedge Funds during Liquidity Crises

Itzhak Ben-David, Francesco Franzoni and Rabih Moussawi
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Francesco Franzoni: Swiss Finance Institute and University of Lugano
Rabih Moussawi: University of Pennsylvania

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: We study hedge funds' trading patterns in the stock market during liquidity crises. On average at the time of a crisis, hedge funds reduce their equity holdings by 9% to 11% per quarter (around 0.3% of total market capitalization). This effect results from large selling by up to a quarter of hedge funds and is not offset by other hedge funds expanding their positions. Dramatic selloffs took place in the 2008 crisis: hedge funds sold about 30% of their stock holdings and almost every fourth hedge fund sold more than 40% of its equity portfolio. We identify two main drivers of this behavior. First, we impute about half of the variation in equity selloffs to a response to lender and investor funding withdrawals. Second, it appears that hedge funds mobilize capital to other (potentially less liquid) markets in the pursuit of more profitable investment opportunities.

Date: 2010-02
New Economics Papers: this item is included in nep-ban and nep-mst
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