Factor models yield an R 2 insignificantly different from 0 for one-third of hedge funds in a broad sample. These funds illustrate the concept of market neutrality and feature lower volatilities, higher Sharpe ratios, and higher alphas than other funds, indicating that they provide a successful alternative investment. However, large portfolios of zero- R 2 funds contain fully half the volatility of portfolios of other funds, suggesting that they feature substantial systematic risk. Furthermore, these funds display an increased probability of failure even after controlling for idiosyncratic volatility. These results indicate the presence of an omitted factor that exposes investors to significant downside risk.

I study the dynamics of investor cash flows in socially responsible mutual funds. Consistent with anecdotal evidence of loyalty, the monthly volatility of investor cash flows is lower in socially responsible funds than in conventional funds. I find strong evidence that cash flows into socially responsible funds are more sensitive to lagged positive returns than cash flows into conventional funds, and weaker evidence that cash outflows from socially responsible funds are less sensitive to lagged negative returns. These results indicate that investors derive utility from the socially responsible attribute, especially when returns are positive.

This paper measures the impact of option introductions on the return variance of underlying stocks. Past research generally finds a significant reduction in stock return variance following the listing of options through 1986. Using a more extensive sample, I compare changes in the return variance of optioned stocks to changes in the return variance of a control group. Since the average change in the control group is statistically indistinguishable from the average change in the optioned stocks, I conclude that option introductions do not significantly affect stock return variance.

[Recent cases of hedge fund fraud have caused large losses for investors and have fueled the debate regarding the ability of regulators to oversee the industry. This article proposes a set of performance flags, based on suspicious patterns in returns, as indicators of a heightened risk of fraud. We collect a sample of hedge funds charged with legal or regulatory violations and find that funds charged with misappropriation, overvaluation, misrepresentation, or Ponzi schemes trigger the performance flags at a higher frequency than other funds.]

We estimate parameters of standard stock selection and market timing models using daily mutual fund returns and quarterly measurement periods. We then rank funds quarterly by abnormal return and measure the performance of each decile the following quarter. The average abnormal return of the top decile in the post-ranking quarter is 39 basis points. The post-ranking abnormal return disappears when funds are evaluated over longer periods. These results suggest that superior performance is a short-lived phenomenon that is observable only when funds are evaluated several times a year.

We study the microstructure of the Pink Sheets and assess the ability of existing theory to capture salient features of this relatively unstructured and unregulated market. Clustering patterns in quotes, quoted spreads, and trade prices indicate that market participants have selected price-dependent tick sizes for different stocks. Clustering intensity varies across stocks as a function of proxies for information availability. Similarly, the bid-ask spread varies as a function of volatility and liquidity. These results suggest (1) microstructure research has established robust predictions of market attributes and (2) unstructured markets are able to develop at least some effective behavioral norms endogenously.

We find a significant discontinuity in the pooled distribution of monthly hedge fund returns: The number of small gains far exceeds the number of small losses. The discontinuity is present in live and defunct funds, and funds of all ages, suggesting that it is not caused by database biases. The discontinuity is absent in the 3 months culminating in an audit, suggesting it is not attributable to skillful loss avoidance. The discontinuity disappears when using bimonthly returns, indicating a reversal in fund performance following small gains. This result suggests that the discontinuity is caused at least in part by temporarily overstated returns.

We study the impact of gender on asset allocation recommendations. Graduate business students and professional wealth managers are randomly assigned a male or female client. Participants recommend an allocation and choose an allocation for themselves. Male students choose a riskier allocation than female students, consistent with existing evidence of a gender difference in risk tolerance, and recommend a riskier allocation. In contrast, male and female wealth managers choose and recommend the same allocation, indicating that male and female finance professionals feature similar risk preferences. In both samples, a subject's allocation choice is the strongest predictor of the recommendation provided.

We show that if true returns are independently distributed and a manager fully reports gains but delays reporting losses, then reported returns will feature conditional serial correlation. We use conditional serial correlation as a measure of conditional return smoothing. We estimate conditional serial correlation in a large sample of hedge funds. We find that the probability of observing conditional serial correlation is related to the volatility and magnitude of investor cash flows, consistent with conditional return smoothing in response to the risk of capital flight. We also present evidence that conditional serial correlation is a leading indicator of fraud.

This paper measures changes in mutual fund trading costs following two reductions in the tick size of U.S. equity markets: the switch from eighths to sixteenths and the subsequent switch to decimals. We estimate trading costs by comparing a mutual fund's daily returns to the daily returns of a synthetic benchmark portfolio that matches the fund's holdings but has zero trading costs by construction. We find that the average change in trading costs of actively managed funds was positive following both reductions in tick size with a larger and statistically significant increase following decimalization. In contrast, index fund trading costs were unaffected.