Abstract
We examine whether exposure to sentiment risk helps explain the cross-sectional variation in hedge fund returns. We find that funds with sentiment beta in the top decile subsequently outperform those in the bottom decile by 0.67% per month on a risk-adjusted basis. Further, we show that some hedge funds have the ability to time sentiment by having high exposure to a sentiment factor when the factor premium is high, and sentiment timing also contributes to fund performance. Our results are robust to controlling for fund characteristics and other risk factors known to affect hedge fund returns and hold for alternative sentiment risk measures. Overall, these findings highlight sentiment risk as a source of limits to arbitrage faced by hedge funds.
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