Working Paper Series no. 373: Commonality in hedge fund returns: driving factors and implications

Abstract

We measure the commonality in hedge fund returns, identify its main driving factor and analyze its implications for financial stability. We find that hedge funds’ commonality increased significantly from 2003 until 2006. We attribute this rise mainly to the increase in hedge funds’ exposure to emerging market equities, which we identify as a common factor in hedge fund returns over this period. Our results show that funds with a high commonality were affected disproportionately by illiquidity and exhibited negative returns during the subsequent financial crisis, thereby providing little diversification benefits to the financial system and to investors.

Matthieu Bussière, Marie Hoerova and Benjamin Klaus
April 2012

Classification JEL : G01, G12, G23

Keywords : Hedge funds, commonality, financial stability