Hedge fund ownership and the informational efficiency of stock prices

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School of Business | Master's thesis
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Date

2018

Major/Subject

Mcode

Degree programme

Finance

Language

en

Pages

75

Series

Abstract

This thesis examines the role that hedge fund ownership has on the informational efficiency of a stock price. The study expands the relatively scarce literature on the topic by examining separately samples of undervalued and overvalued shares. Also periods of financial crisis are considered separately. A residual income based valuation method is used to compute a stock specific misvaluation measure as a proxy for stock specific price efficiency. A sample of 75,457 stock-quarter observations over 2006:Q2-2015:Q4 from NYSE, Amex, and Nasdaq is analyzed using the Fama-MacBeth regression method. The estimated cross-sectional effect of hedge fund holdings decreases misvaluation for both under- and overvalued shares and persists beyond controlling for hedge fund trading, increase in short selling, and improvements in liquidity and information production. However, as hypothesized the price efficiency promoting effect of hedge fund holdings is stronger for undervalued shares both in terms of magnitude and statistical significance. It is shown that in periods of financial distress, when the funding liquidity for hedge funds is likely impaired, the effect is reversed and hedge fund holdings become detrimental to price efficiency. The results confirm that hedge funds play an important role when it comes to the efficiency of the stock markets. Furthermore, the findings also highlight that the special circumstances under which the positive effect of hedge fund holdings may be reversed must be understood for optimal design of markets, protocols and regulation.

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Thesis advisor

Nyberg, Peter

Keywords

hedge funds, market efficiency, misvaluation, undervaluation, overvaluation

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