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What Is the Nature of Hedge Fund Manager Skills? Evidence from the Risk-Arbitrage Strategy

Published online by Cambridge University Press:  29 July 2016

Charles Cao ,
Bradley A. Goldie ,
Bing Liang  and
Lubomir Petrasek
Charles Cao
Affiliation:
qxc2@psu.edu, Pennsylvania State University, Smeal College of Business, University Park, PA 16802
Bradley A. Goldie
Affiliation:
goldieba@miamioh.edu, Miami University, Farmer School of Business, Oxford, OH 45056
Bing Liang*
Affiliation:
bliang@isenberg.umass.edu, University of Massachusetts Amherst, Isenberg School of Management, Amherst, MA 01003, and China Academy of Financial Research
Lubomir Petrasek
Affiliation:
lubomir.petrasek@frb.gov, Board of Governors of the Federal Reserve System, Washington, DC 20551.
*
*Corresponding author: bliang@isenberg.umass.edu
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Abstract

To understand the nature of hedge fund managers’ skills, we study the implementation of risk arbitrage by hedge funds using their portfolio holdings and comparing them with those of other institutional arbitrageurs. We find that hedge funds significantly outperform a naive risk-arbitrage portfolio by 3.7% annually on a risk-adjusted basis, whereas non–hedge fund arbitrageurs fail to outperform the benchmark. Our analysis reveals that hedge funds’ superior performance does not reflect fund managers’ ability to predict or affect the outcome of merger and acquisition deals; rather, hedge fund managers’ superior performance is attributed to their ability to manage downside risk.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 3 , June 2016 , pp. 929 - 957
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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