Close communications: hedge funds, brokers and the emergence of a consensus trade

Jan Simon, Yuval Millo, Neil Kellard and Ofer Engel

Journal of Network Theory in Finance

Abstract: ABSTRACT In this paper, we examine how communication practices among competing market;actors lead to overembeddedness, and whether such practices impact on market-wide;phenomena such as prices and risk. Data is collected from interviews and observations,;with hedge fund industry participants in Europe, the United States and Asia.;Quantitatively analyzing the mapped social network, we find that decision making;relies on an elaborate two-tiered structure of connections among hedge fund managers,;and between them and brokers. This structure is underpinned by idea sharing;between competing hedge funds leading to overembeddedness and an increased probability;of popular consensus trades. We present a detailed case study that illustrates;the role that communication between competing hedge funds plays in the creation of;consensus trades, and shows that such trades affect prices by introducing an additional;risk: the disregarding of information from sources outside the trusted connections.

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