Wednesday, April 6, 2011

Paper: "Capitalizing on Capitol Hill: Informed Trading by Hedge Fund Managers"

I've been doing it all wrong. Don't slam the politicians and lobbyists, embrace them.
[told ya -ed]
Via Professor Jeffrey Pontiff's Boston College website:

In this paper, we examine the hypothesis that hedge fund managers obtain an informational advantage in securities trading through their connections with lobbyists. Using datasets on hedge fund long-equity holdings and lobbying expenses from 1999 to 2008, we show that hedge funds that are connected to lobbyists tend to trade more heavily in politically sensitive stocks than do non-connected funds. Furthermore, using a difference-in-differences approach, we …find that connected hedge funds, relative to non-connected ones, outperform by 1.6 to 2.5 percent per month on their holdings of politically sensitive stocks, relative to their non-political holdings. These results suggest that hedge fund managers exploit private information, which can be an important source of their superior performance. Our study provides evidence for the ongoing debate about regulatory reform governing informed trading based on private political information.

From the paper:

...Political decisions made by governments can move stock prices because such decisions often have profound implications for corporate strategies and firm profitability. As a result, political decisions are of considerable interest to financial market participants.

Lobbyists, through their interaction with legislators, can have access to nonpublic political information, such as the likely outcome of various legislative votes, regulatory proceedings, congressional investigations, and so on. A Wall Street Journal article (“Hedge Funds Use Lobbyists for Tips in Washington”, Wall Street Journal, December 8, 2006) reports that hedge funds are findingWashington to be a “gold mine of market-moving information.”They hire lobbyists not to influence the government, but to obtain private information about ongoing or impending government actions. The article quotes a congressional aide as saying “[t]he amount of insider trading going on in these halls [of the Capitol] is incredible.”...