Do Hedge Funds Increase Non-systematic Risk

This paper studies the effect of hedge-fund trading on idiosyncratic risk. Idiosyncratic risk in this paper, also known as individual risk, is caused by individual factor. Using Fama-French three-factor model, author of this paper get the proxy variable of idiosyncratic risk-idiosyncratic volatility. Statistical results indicate that 47% of total risk is idiosyncratic risk, which has become an important part of China’s stock market risks. Research on the effect of hedge-fond trading on idiosyncratic risk can be significant for China’s stock market regulatory authorities and investors. So as a professional institutional investors, whether t hedge funds will affect the stock of idiosyncratic risk?Report of listed companies disclose quarterly details of institutional investors, including public offering funds, the identification of these institutions can bring researchers the proportion of hedge fund holdings,which provides the data base for this paper.To study the impact of hedge funds holding on the idiosyncratic risk of stocks, first of all, define risk as discussed in this paper is:the uncertain risk faced by investors hold stocks. According to different factors, the risk of stock returns can be divided into systematic risk and idiosyncratic risk, in which idiosyncratic risk by individual factors are the main object of this study. Factors that affect the idiosyncratic risk can generally be divided into two parts, one is the company’s own quality factor, and another is trading behavior of shareholders. Institutional investors can be divided into the value of investors and speculators, the researchers found that the shorter the investment cycle of institutional investors is significant for the stability of individual stock prices; Hedge funds as highly professional institutional investors, transaction frequency and transaction speeds are significantly higher than other types of institutions.Hedge funds are not the type refers to a company, but rather refers to a special type of investment, funds and trust scheme can be included. Hedge funds seek stable substantial absolute returns, which not affected by market risk; high levels of incentive system attract a lot of talent into this industry, such transactions of hedge funds become more flexible. Hedge funds generally have strict risk management policy. In "normal" times, if a sufficiently large amount of capital is dedicated to the strategy, this activity reduces idiosyncratic return volatility by partially absorbing idiosyncratic shocks. However, most institutional traders have implicit or explicit limits on their loss bearing capacity. Regardless of its source, this constraint might force funds to reduce their positions after a series of adverse shocks. Thus, when the initial idiosyncratic shock increases to a particularly high level, the induced loss on the funds following the long-short strategy triggers forced liquidation.Using idiosyncratic volatility and the proportion of tradable shares of listed companies, in combination with other explanatory variables, build linear regression model, do panel data regression. The results obtained confirm:hedge funds holding would have an expanded role for idiosyncratic risk, and the higher the level of the non-systemic volatility is, the stronger hedge funds amplification is.