Hedge Fund Arbitrage of New Anomalies

Do hedge funds rapidly move to exploit, and thereby weaken/extinguish, newly discovered stock return anomalies? In the December 2022 version of their paper entitled “Anomaly Discovery and Arbitrage Trading”, Xi Dong, Qi Liu, Lei Lu, Bo Sun and Hongjun Yan measure the post-publication role of hedge funds on 99 published stock return anomalies (or latest working paper dates if unpublished). For each anomaly, they:

1. Calculate a five-year rolling correlation of monthly returns between the extreme tenths (deciles 1 and 10) of anomaly stock sorts, minus the correlation between deciles 5 and 6 to control for unrelated trends.
2. Analyze via quarterly SEC Form 13F holdings aggregate U.S. hedge fund differential trading of extreme decile stocks.

Using monthly returns for the 99 anomalies as available starting in 1926 and hedge fund SEC Form 13F filings as available starting 1981, both through 2020, they find that: (more…)