Hedge Fund Connectedness and the Emergence of a Consensus Trade
Abstract: (Via All Academic)
In spite of the central role they play in financial markets, the ways in which investment decisions are made in hedge funds is virtually unexamined in the academic literature. This paper is the first to use triangulating interviews, field observations and social network analysis to analyze this topic. The empirical material in the paper consists of 60 hedge fund managers and brokers, working for 26 hedge funds and 8 brokerage firms in Europe, the United States and Asia. These hedge funds managed 15% of the global assets managed by hedge funds, while 7 of the top 10 global prime brokers are represented. The findings reveal the social and organizational infrastructure that underpins the transfer of investment information among hedge funds and between them and brokers. Analyzing in detail the norms and practices of this information transfer sheds new light on the emergence of the ‘consensus trade’, the phenomenon of identical trades across hedge funds. Our findings have important implications for risk management and regulation as they reveal the existence of risk hereto not recognized by investment professionals or regulators: ‘network risk’. These findings also contribute to the empirical literature of economic sociology in general and the social studies of finance in particular.