Sep

27

I am curious about the claim that hedge fund alpha derives from timing entries and exits in high-vol stocks. There are lots of interesting trailhead links provided, too.

Hedge funds and the positive idiosyncratic volatility effect
Turan G. Bali, McDonough School of Business, Georgetown University
Florian Weigert, Institute of Financial Analysis, University of Neuchatel, Switzerland and Centre for Financial Research, Cologne, Germany
This Version: July 2023

Abstract

While it is established that idiosyncratic volatility is negatively priced in the cross-section of stock returns, the relation between idiosyncratic volatility and hedge fund returns is largely unexplored. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6 percent p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds’ idiosyncratic volatility is a measure of managerial skill.


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