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Derivatives do affect mutual fund returns: Evidence from the financial crisis of 1998

Authors

  • Charles Cao,

    Corresponding author
    1. The Smeal Chair Professor of Finance, Smeal College of Business Administration, Pennsylvania State University, University Park, Pennsylvania
    • Smeal College of Business Administration, 338 Business Building, Pennsylvania State University, University Park, Pennsylvania 16802
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  • Eric Ghysels,

    1. The Bernstein Distinguished Professor, University of North Carolina, Chapel Hill, North Carolina
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  • Frank Hatheway

    1. Chief Economist of the NASDAQ OMX Group Inc., New York, New York
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  • The views expressed herein are those of the authors and do not necessarily reflect the views of the NASDAQ OMX Group Inc. We thank Daniel Deli for providing the N-SAR data, and Jennifer Juergens, Wilson Kong, and XiaoxinWang for excellent research assistance. Participants at the Cornell University's Derivative Securities Conference, Peter Carr, Ian Domowitz, Robert Jarrow, Bill Kracaw, Harold Mulherin, and Robert Webb (the Editor) provided valuable comments and suggestions.

Abstract

Using a unique data set of detailed balance sheet information on mutual funds, we find that most mutual funds using derivatives do so to a very limited extent that has little discernable impact on returns. However, there exist two types of funds that make more extensive use of derivatives, global funds and specialized domestic equity funds. The risk and return characteristics of these two groups of funds are significantly different from funds employing derivatives sparingly or not at all. Fund managers time their use of derivatives in response to past returns. Evidence during the financial crisis of August 1998 supports the hypothesis that the effects of derivative use are most pronounced during the periods of extreme movement. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark 31:629–658, 2011

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