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Hedge fund attributes and volatility around equity offerings

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Abstract

The purpose of this paper is to explore the potential influence of hedge fund attributes on idiosyncratic volatility (IVOL) in excess stock returns for 705 firms undergoing seasoned equity offerings (SEOs). This investigation is important due to the pervasive concerns about the impact of hedge funds on volatility. We choose a time frame from 1999 to 2005 covering two periods that could impact IVOL differently: the internet-technology bubble period and the post-bubble period. Our time frame includes the breakpoint year of 2000 that marks a downward trend in IVOL from 2000 to 2008. We explore this IVOL drop for a sample of SEOs and find that the decline in IVOL for this sample can be primarily related to the rapid increase in the hedge fund industry size and to the increasing use of leverage by hedge funds. This trend is also related to the increasing use of a relative value (arbitrage) strategy and the decreasing use of an event-driven strategy. IVOL for our sample also appears to decrease with greater hedge fund performance except when hedge funds are riding the pre-SEO stock price run-up. The downward shift in IVOL for our SEO sample around their offering dates is better explained by hedge fund attributes than by non-hedge fund attributes. In conclusion, our findings suggest that the rapid increase in the hedge fund industry offer an explanation for the mysterious decline in IVOL that has been witnessed since 2000.

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Notes

  1. While not included due to brevity concerns, we found systematic risk to be a small portion of the total risk for our sample of SEOs tested. For example, for the short-run periods we tested, the systematic risk is about one-twentieth of the idiosyncratic risk. For the long-run periods we tested, the systematic risk is about one-tenth of the idiosyncratic risk.

  2. Because short sellers are borrowing shares from their broker, they must be able to acquire the shares when prices have bottomed where the bottom is greater when there is greater discounting. For our sample, the offer date typically occurs six days after the registration date, which would be day +6. The average closing price falls −3.34% from day −6 to day +6. Thus, on average, even without factoring in SEOs of greater discounting, a short–selling strategy can be profitable if we extend the trading period past the offer date as does Henry and Koski (2010).

  3. For our sample, an investor could make 1.73%, on average, from buying an SEO at the closing pricing on day 0 and selling three days later. Greater returns could also be made for lengthier short–run periods. For example, 2.45% could be made from day 0 to day +8. While 1.73% and 2.45% are only average numbers and may not cover transaction costs, traders with inside information would be more selective and choose only those SEO firms for which acceptable profits could be found. In the process, they could reduce stock return volatility.

  4. The “2 and 20 fee structure” from which 0.22 is derived consists of management fees of 0.02 and incentive or performance fees of 0.20. This fee structure implies a monthly fee of 0.01531.

  5. Technically, a pre–SEO period should not include day 0 (the day of the SEO announcement) but, for simplicity purposes, we refer to such a period as a pre–SEO period.

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  1. Washburn University School of Business, 1700 SW College Avenue, Topeka, KS, 66621, USA

    Robert M. Hull, Sungkyu Kwak & Rosemary Walker

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  1. Robert M. Hull
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  2. Sungkyu Kwak
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  3. Rosemary Walker
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Correspondence to Rosemary Walker.

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Hull, R.M., Kwak, S. & Walker, R. Hedge fund attributes and volatility around equity offerings. J Econ Finan 38, 359–382 (2014). https://doi.org/10.1007/s12197-011-9221-8

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  • DOI: https://doi.org/10.1007/s12197-011-9221-8

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