The Dark Side of Alternative Asset Markets: Networks, Performance and Risk Taking

Abstract

When actors invest in making strong network ties (relationships) with other actors, such ties can potentially influence behavior and subsequent financial performance, but the strength and direction of these effects is debated. Using original fine-grained data that documents the nature and extent of the relationships between Hedge Funds through their Prime Brokers (banks that provide leverage, issue credit lines and serve as bridges between Hedge Funds) we probe the social topology of Hedge Fund to Hedge Fund relationships that shapes this global alternative asset market. Contrasting much recent research that tends to stress the positive effects of network relationships, we find that investing in network relationships in this industry appears to have a dark side in terms of both performance and risk taking; where we probe various measures of both performance and risk in line with recent finance literature. We explore the reasons for these effects, and conclude that investing in Hedge Fund to Hedge Fund network ties can lead to inferior performance and increased risks that may not benefit the investor.