Hedge Fund Stock Trading in the Financial Crisis of 2007-2008

We document a drastic reduction in hedge fund stock ownership during the recent financial crisis. In the two quarters around the Lehman collapse (2008Q3-Q4), hedge funds cut their equity holdings by about 29% and nearly every fourth fund dumped more than 40% of its equity portfolio in each quarter. We directly establish that investor redemptions were a primary driver of these selloffs and provide suggestive evidence that pressure from lenders was also an important determinant of stock sales. These channels were more relevant for funds with low restrictions on investors’ withdrawals and low bargaining power vis-a-vis their brokers. Also consistent with fire sales, hedge funds were more likely to sell high-volatility stocks and liquid stocks. Finally, we show indirect evidence suggesting that part of the stock selloffs occurred because hedge funds reallocated capital to other assets in a flight to quality or in pursuit of profit opportunities. _____________________ * We thank Viral Acharya, Giovanni Barone-Adesi, Alexander Eisele, Vyacheslav Fos, Craig Furfine, YeeJin Jang, Pete Kyle, Jose-Miguel Gaspar, Massimo Massa, Loriana Pelizzon, Alberto Plazzi, Steven Ongena, Tarun Ramadorai, Ronnie Sadka, Rene Stulz, Dimitri Vayanos, and seminar and conference participants at the Ohio State University, the 2 Annual Conference on Hedge Funds in Paris, the 3 Erasmus Liquidity Conference, the Wharton/FIRS pre-conference, the FIRS conference (Florence), LUISS University (Rome), and the C.R.E.D.I.T. Conference (Venice), for helpful comments.