Hedge funds and their implications for financial stability

The paper provides an overview of the hedge fund industry, mainly from a financial stability and European angle. It is primarily based on an extensive analysis of information from the TASS database. On the positive side of the financial stability assessment, hedge funds have a role as providers of diversification and liquidity, and they contribute to the integration and completeness of financial markets. Possible negative effects occur through their impact on financial markets (e.g. via crowded trades) and financial institutions (e.g. via prime brokerage). Several initiatives have been launched to address these concerns and most of them follow indirect regulation via banks. If any direct regulation were to be considered, it would probably have to be implemented in a coordinated manner at the international level. At the EU level there is currently no common regulatory regime, although some Member States have adopted national legislation.Asset management, crowded trades, financial regulation, financial stability, hedgefunds, prime brokerage, risk management.

Hedge funds and their implications for financial stability

The paper provides an overview of the hedge fund industry, mainly from a financial stability and European angle. It is primarily based on an extensive analysis of information from the TASS database. On the positive side of the financial stability assessment, hedge funds have a role as providers of diversification and liquidity, and they contribute to the integration and completeness of financial markets. Possible negative effects occur through their impact on financial markets (e.g. via crowded trades) and financial institutions (e.g. via prime brokerage). Several initiatives have been launched to address these concerns and most of them follow indirect regulation via banks. If any direct regulation were to be considered, it would probably have to be implemented in a coordinated manner at the international level. At the EU level there is currently no common regulatory regime, although some Member States have adopted national legislation

Short selling in extreme events

We study the association between daily changes in short selling activity and financial stock prices during extreme events using TailCoR, a measure of tail correlation. For the largest European and US banks, as well as European insurers, we uncover a strong relation during exceptional (extreme) days and a weak relation during normal (average) days. Examining days with large increases in short positions and large downfalls in stock prices, we find evidence of both momentum and contrarian short selling taking place. For North American bank stocks, contrarian short selling appears more practiced than for European bank and insurance stocks. We find that the uncovered relationship decreases with firm size and increases during ban periods, which is in line with short selling becoming more informative when constrained.This work was supported by the Communauté française de Belgique [grant number 13/17-055]

Hedge Funds, Financial Intermediation, and Systemic Risk

Hedge funds are significant players in the U.S. capital markets, but differ from other market participants in important ways such as their use of a wide range of complex trading strategies and instruments, leverage, opacity to outsiders, and their compensation structure. The traditional bulwark against financial market disruptions with potential systemic consequences has been the set of counterparty credit risk management (CCRM) practices by the core of regulated institutions. The characteristics of hedge funds make CCRM more difficult as they exacerbate market failures linked to agency problems, externalities, and moral hazard. While various market failures may make CCRM imperfect, it remains the best line of defense against systemic risk

Short selling in extreme events

We study the association between daily changes in short selling activity and financial stock prices during extreme events using TailCoR, a measure of tail correlation. For the largest European and US banks, as well as European insurers, we uncover a strong relation during exceptional (extreme) days and a weak relation during normal (average) days. Examining days with large increases in short positions and large downfalls in stock prices, we find evidence of both momentum and contrarian short selling taking place. For North American bank stocks, contrarian short selling appears more practiced than for European bank and insurance stocks. We find that the uncovered relationship decreases with firm size and increases during ban periods, which is in line with short selling becoming more informative when constrained.This work was supported by the Communauté française de Belgique [grant number 13/17-055]

Short Selling in the Tails

Short selling plays a crucial role for price discovery and liquidity purposes yetnational governing authorities decided to ban short selling in periods of extreme pricemovements, on the grounds that short selling can exacerbate price downturns. Whereasmost of the literature analyses the average relation between short selling and pricechanges, our study focuses on the relation that occurs during extreme events, usinga new paradigm that stems from the literature on tail correlations. For the largestEuropean and US banks, as well as European insurers, we uncover a very strong relationwhen both variables are in their tails. In normal times, no negative association is found,which favours the view that short sellers act as price stabilizers. But during turmoil,short selling relates with excessive price drops that can put the market under seriousstress.info:eu-repo/semantics/publishe