The Role of Hedge Funds in the Asset Pricing: Evidence from China

We document that hedge funds nurture mispricing in the Chinese financial market. We exploit the relationship between hedge fund holdings and the degree of mispricing in case that hedge fund holdings of stocks are mainly for arbitrage purpose but not for hedging, and that with and without short-selling restrictions. Hedge funds intentionally hold overvalued stocks. Their trades, which generate an abnormal return to 1.78% per month, also impede the dissipation of stock mispricing. Further, we find trend chasing may be the reason why hedge funds prefer to hold overvalued stocks. This research sheds new lights on the information content and potential investment value of hedge funds holdings in emerging markets.