Cash flows to hedge funds are highly sensitive to performance streaks, a streak being defined as subsequent quarters during which a fund performs above or below a benchmark, even after controlling for a wide range of common performance measures. At the same time, streaks have limited predictive power regarding future fund performance. This suggests investors weigh information suboptimally, and their decisions are driven too strongly by a belief in continuation of good performance, consistent with the “hot hand fallacy.” The hedge funds that investors choose to invest in do not perform significantly better than those they divest from. These findings are consistent with overreaction to certain types of information and do not support the notion that sophisticated investors have superior information or superior information processing abilities.
|Number of pages||22|
|Early online date||12 Aug 2021|
|Publication status||Published - Jun 2022|
Bibliographical noteFunding Information:
The authors benefited from extensive discussions with Francis de Vericourt, Ben Jacobsen, Yaakov Kareev, Anthony Lynch, Dimitri Vayanos, and Georg Weizsäcker. The authors thank Vikas Agarwal, Yong Chen, Frank de Jong, Alberta Di Giuli, Bart Keijsers, Simone Kohnz, Ignacio Palacios-Huerta, Tarun Ramadorai, David Stolin, Zheng Sun, Ashley Wang, Florian Weigert, two anonymous referees, and the associate editor for valuable and constructive comments and participants at the 2016 American Economic Association Annual Meetings, the 2015 China International Conference in Finance, the 2008 European Finance Association Annual Meetings, the 2007 American Finance Association Meetings, and the 2006 European Economic Association Annual Meetings. Dmitry Ilin and Zhou Ren provided excellent research assistance. Early versions of this manuscript were circulated under the title “Do Sophisticated Investors Believe in the Law of Small Numbers?”.
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