A tale of feedback trading by hedge funds |
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| Institution: | 1. VU University Amsterdam, Amsterdam, The Netherlands;2. Erasmus School of Economics, Rotterdam, The Netherlands;3. VU University Amsterdam and Tinbergen Institute, Amsterdam, The Netherlands;4. Loyens & Loeff, Paris, France;1. Aston Business School, Aston University, Aston Triangle, Birmingham B4 7ET United Kingdom;2. Department of Economics, University of Patras, University Campus, Rio 26504 Greece;1. Goethe University Frankfurt, Germany;2. Banco de Portugal, Portugal;3. Universidade Nova de Lisboa, Portugal;4. CEFAGE, Portugal;5. University of Alicante, Spain;1. Zagreb School of Economics and Management, Croatia;2. The Institute of Economics, Zagreb, Croatia;3. University of Alabama, USA;1. University of Technology, Sydney, Finance Discipline Group, UTS Business School, P.O. Box 123, Broadway, NSW 2007, Australia;2. University of New South Wales, School of Banking and Finance, UNSW Business School, Sydney, NSW 2052, Australia |
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| Abstract: | This paper studies the extent of feedback trading at the factor level by hedge fund managers. We show that fund managers continuously adjust their exposure to different risk factors conditional on the recent performance of these factors. The majority of managers apply a positive feedback strategy, whereas the remaining managers use a negative feedback strategy. In addition, we find some evidence for factor timing ability, although managers appear to be more backward looking than forward looking. We show that positive feedback trading can be beneficial to fund performance in our setup. If managers applied the positive feedback strategy more aggressively, however, they could benefit more from it. As such, the “smart switching benchmark” can be used to assess the risk-adjusted performance of hedge funds. |
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