Hedge Fund Holdings and Stock Market Efficiency

We study the relation between hedge fund equity holdings and measures of informational efficiency of stock prices derived from intraday transactions as well as daily data. Our findings support the role of hedge funds as arbitrageurs who reduce mispricing in the market. Hedge funds invest in stocks that are relatively inefficiently priced, and the price efficiency of these stocks improves after hedge funds increase their holdings. Hedge fund ownership contributes more to efficient pricing than ownership by other types of institutional investors. However, stocks held by hedge funds experienced large declines in price efficiency during several liquidity crises. Received July 27, 2016; editorial decision January 07, 2017 by Editor Wayne Ferson.