The Allocative Role of Prime Brokers (paper link)
- Job Market Paper
This is the first paper to investigate and quantify how prime brokers help connect investors with hedge funds. I analyze the impact of the prime broker channel on fund flows and performance. I find that, among hedge funds that share a prime broker, top performing funds enjoy 15.43 percentage points higher fund flows over the next year. This result controls for overall performance and demonstrates that the prime broker channel is important for fund flows. In addition, hedge funds that receive the largest flows tend to subsequently underperform by 3.05 percentage points. This result is stronger for hedge funds that pay higher fees to prime brokers. Overall, my results suggest that prime brokers act as gatekeepers for less-sophisticated investors and actively affect capital allocation in the hedge fund market.
The Effect of Skewness on the Demand for and the Performance of Hedge Funds (with A. Langut, draft available upon request)
In the market for hedge funds, we test and confirm the hypothesis that sophisticated investors chase positively skewed returns. We also find that hedge fund skewness negatively predicts future fund-level returns. This indicates that sophisticated investors are investing in funds exactly when the fund are expected to underperform. The short-term and asymmetric nature of flow-predictability implies an attention channel. Prospect theory predicts that positively skewed assets will have negative future returns. We rule out several alternative channels for return-predictability.
Rehypothecation and the Pledgeability of Risky Collateral (draft available upon request)
In this paper, I demonstrate that rehypothecation — the act of reusing collateral — can increase the pledgeability of risky collateral. In a standard collateralized loan, the lender faces the joint risk that the borrower will default and the pledged collateral will fail. If the pledged collateral itself has been rehypothecated, then a third-party (the ultimate borrower) is obligated to make a payment when the collateral fails. This third-party payment can reduce the risk the lender faces, and increase the pledgeability of the collateral. This feature of rehypothecation can help explain why risky subprime securities were used as collateral in money markets before the Financial Crisis of 2007-2009.
Works in Progress
Hedge Fund Media Exposure: Third-Party Marketers as Gatekeepers
I find evidence that third-party marketing firms manage media exposure for their hedge fund clients. I build a panel dataset of hedge fund news articles from the Wall Street Journal, and find that, in general, news articles are negatively related to future fund flows. This implies that the media tends to cover bad news about hedge funds. However, the results reverse for funds that have a third-party marketer. News about these funds is positively related to future fund flows. Taken together, these results imply that third-party marketers act as gatekeepers for media exposure.
Who Responds to Hedge Fund Advertising? Institutional or Individual Investors? (with N. Mojir)
This paper explores recent changes in hedge fund advertising regulations by measuring relative importance of advertising for institutional/individual investors. The ban on advertising in the hedge fund industry, going back to the Securities Act of 1933, was recently lifted as part of the Jumpstart Our Business Startups Act (i.e. the JOBS Act) of 2012. While opponents of the JOBS Act argue that poor-performing hedge funds would take advantage of it by targeting less-sophisticated individual investors, its proponents argue that it would put better hedge funds on the radar of large institutional investors and improve the allocation of funds in the market as a whole. To assess these arguments, we combine data on performance of hedge funds from Lipper TASS data base with data on hedge fund clientele base and investment positions from SEC forms ADV and 13F. Taking advantage of the fact that the JOBS Act affects only US-based investors, we use a difference-in-difference strategy to answer the following questions: Does allowing hedge funds to advertise result in increased share of individual investors? Is the increase in share of individual investors more towards hedge funds with lower alpha (i.e. risk-adjusted excess return) that take higher systematic risk? Has the market share for hedge funds with better performance increased after the JOBS Act?
The Convenience Yield on Private Safe-Assets (slides available upon request)
In this paper, I build a model of the convenience yield on privately produced safe-assets. Banks optimally create safe-assets to meet investor liquidity demand. In bad times, liquidity shocks lead to fire-sales across all assets. At-risk investors value safe-assets because these are discounted less in dollar terms. The convenience yield is the relative overpricing of safe-assets from the point of view of investors that are not directly exposed to the liquidity shock. The convenience yield is positively related to the mass of short-term investors, and negatively related to the ability of banks to create safe assets.