There is a nifty paper in the October issue of the Journal of Finance arguing that hedge funds, contrary to orthodox efficient market theory, rode the technology bubble of the late 1990s rather than trading against said overpriced stocks. What’s more, the authors argue, hedge funds rode the bubble on purpose, avoiding more of the subsequent losses than the average investor.
Hedge Funds and the Technology Bubble
MARKUS K. BRUNNERMEIER and STEFAN NAGEL
This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage.