Hedge fund networks, information dissemination, and stock price comovement: Evidence from China

Abstract

We define a hedge fund network as consisting of weak ties based on common holdings. By creating a filtered dataset of stocks held by hedge funds in China from 2010 to 2019, we examine the effect of the network on stock return comovement and further test the incentive-compatible conditions for honest communication between competitors (Stein, 2008). First, we find that the weak ties in a social network affect the behaviour of hedge fund managers, when formal institutions are imperfect. Second, we find that listed firms held by hedge funds are exposed to an information network that is composed of hedge funds. The higher the hedge fund network density is, the more likely information dissemination is, and the weaker the stock price comovement is. Third, our results support Stein's (2008) two major conclusions: a network effect exists only within stable relationships, and the more central a stock is in the network, the stronger the network effect is. After controlling for various external factors that might influence the hedge fund network's information diffusion mechanism, all the results meet our theoretical expectations. Overall, we contribute to the literature by determining the role of the hedge fund network as an information transmitter in weak ties and by providing empirical evidence on the theory of honest communication among competitors.