Friday, November 18, 2011

25 Percent Of Sampled Hedge Funds Misprice Their Equity Stock Holdings

From the research paper, "Caught in the Act: How Hedge Funds Manipulate Their Equity Positions" by Gjergji Cici, College of William and Mary - Mason School of Business, Alexander Kempf, University of Cologne - Department of Finance and Alexander Puetz, University of Cologne - Department of Finance:
Focusing on the position valuations of common stocks, presumably the most liquid securities, allows us to document direct evidence of manipulation while eliminating the possibility of unintentional mispricing due to stale prices or pricing discretion.
we document that about 150 thousand positions (roughly seven percent) out of about 2.3 million positions are mismarked. To get a sense for the economic magnitude of mismarking, we show that the reported valuations for these 150 thousand positions deviate from CRSP-based valuations by roughly 2.5 percent in absolute terms. Such a level of mismarking, although not extreme, is not trivial in an economic sense
Previous research suggests that the majority of hedge fund advisors rely on independent pricing committees or external parties to compute their NAVs, and among these advisors fewer pricing irregularities are to be found (see, Cassar and Gerakos (2011)). Our results from the cross-section of hedge fund advisors are consistent with this previous finding, as we show that the majority of hedge fund advisors show little or no mismarking. However, a non-trivial fraction of roughly 25 percent of our sample advisors shows mismarking of an economically significant magnitude.
Our findings from a battery of tests show that the documented mismarking is strongly related to hedge fund incentives, and therefore is not the byproduct of some unknown random process.

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