Discussion Paper

No. 2019-31 | April 30, 2019
Market runs of hedge funds during financial crises

Abstract

A hedge fund’s capital structure is fragile because uninformed fund investors are highly loss sensitive and easily withdraw capital in response to bad news. Hedge fund managers, sharing common investors and interacting with each other through market price, sensitively react to other funds’ investment decisions. In this environment, panic-based market runs can arise not because of systematic risk but because of the fear of runs. The authors find that when the market regime changes from a normal state to a “bad” state (in which runs are possible), hedge funds reduce investment prior to runs. In addition, the market runs are more likely to occur in a market where hedge funds hold greater market exposure and uninformed traders have greater sensitivity to past price movement.

JEL Classification:

G01, G23

Assessment

  • Downloads: 181

Links

Cite As

Sangwook Sung, Hoon Cho, and Doojin Ryu (2019). Market runs of hedge funds during financial crises. Economics Discussion Papers, No 2019-31, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2019-31


Comments and Questions


Anonymous - Finance
May 03, 2019 - 05:33

This study theoretically shows that the irrational behavior of uninformed investors indeed hinder the investment decision of hedge fund in equilibrium. This study is meaningful for many researchers and practitioners in the sense that the problem may distort the investment decision. Based on this study, many follow-up studies can analyze ...[more]

... features of uninformed investors and their impact on the hedge fund.


Anonymous - Referee Report 1
June 04, 2019 - 09:32

See attached file


Doojin Ryu - Author Reply
June 16, 2019 - 00:45

Author Responses and Revision Plans

Discussion Paper 2019-31
Title: Market runs of hedge funds during financial crises
Authors: Sangwook Sung, Hoon Cho, and Doojin Ryu

Thank you very much for giving us the two referee reports. The two referees highly evaluate this paper as follows.

1) The ...[more]

... goal of the paper, i.e. to shed light on the detailed interaction of agents in financial markets that gives rise to strategic fragility, is interesting and definitely deserves scholarly attention.The paper tells a reasonable story that indeed seems to match stylized facts from the financial crisis.

2) I think the paper investigates a relevant and interesting issue. Understanding the determinants behind fund managers’ decision to cut their arbitrage positions and how their initial asset allocation affects the exposure to runs is very important also in light of the recent crisis. In particular, I praise the authors for trying to endogenize the short-term return (also referred to as market price). This is not only relevant and more realistic than having a fixed liquidation value, but it is also, especially in the context of global games model, quite challenging. In my opinion, the endogenization of the price at which risky assets are sold in the market to raise liquidity at short notice would represent a key contribution of this paper to the existing literature.

As the referees suggests, we believe that this paper has a potential and contributes to the existing literature. After the editor makes a formal revision decision, we will rebuild our model setup and totally reconstruct our model and framework based on the referee comments. It will be a long journey. However, we will do our best to enhance the quality and readability of this paper considering all of referee comments.

Warm regards,
Doojin

Doojin Ryu (corresponding author) is a Tenured Professor at College of Economics, Sungkyunkwan University (SKKU). Ryu is the Editor of Investment Analysts Journal (SSCI) and the subject editors of Emerging Markets Review (SSCI).
https://sites.google.com/site/doojinryu/home/papers


Anonymous - Referee Report 2
June 11, 2019 - 10:06

see attached file


Doojin Ryu - Author Reply
June 16, 2019 - 00:46

Author Responses and Revision Plans

Discussion Paper 2019-31
Title: Market runs of hedge funds during financial crises
Authors: Sangwook Sung, Hoon Cho, and Doojin Ryu

Thank you very much for giving us the two referee reports. The two referees highly evaluate this paper as follows.

1) The ...[more]

... goal of the paper, i.e. to shed light on the detailed interaction of agents in financial markets that gives rise to strategic fragility, is interesting and definitely deserves scholarly attention. The paper tells a reasonable story that indeed seems to match stylized facts from the financial crisis.

2) I think the paper investigates a relevant and interesting issue. Understanding the determinants behind fund managers’ decision to cut their arbitrage positions and how their initial asset allocation affects the exposure to runs is very important also in light of the recent crisis. In particular, I praise the authors for trying to endogenize the short-term return (also referred to as market price). This is not only relevant and more realistic than having a fixed liquidation value, but it is also, especially in the context of global games model, quite challenging. In my opinion, the endogenization of the price at which risky assets are sold in the market to raise liquidity at short notice would represent a key contribution of this paper to the existing literature.

As the referees suggest, we believe that this paper has potential and contributes to the existing literature. After the editor makes a formal revision decision, we will rebuild our model setup and totally reconstruct our model and framework based on the referee comments. It will be a long journey. However, we will do our best to enhance the quality and readability of this paper considering all of the referee comments.

Warm regards,
Doojin

Doojin Ryu (corresponding author) is a Tenured Professor at College of Economics, Sungkyunkwan University (SKKU). Ryu is the Editor of Investment Analysts Journal (SSCI) and the subject editors of Emerging Markets Review (SSCI).
https://sites.google.com/site/doojinryu/home/papers