Explanatory Power of Monetary Policy on Hedge Fund Returns

Seeing as the Federal Reserve is primarily responsible for maintaining long-term interest rates, stabilizing capital markets, and preserving market liquidity, one would expect a significant relationship between hedge funds... [ view full abstract ]

Seeing as the Federal Reserve is primarily responsible for maintaining long-term interest rates, stabilizing capital markets, and preserving market liquidity, one would expect a significant relationship between hedge funds return characteristics and changes in monetary policy. This paper tests whether monetary policy carried out by the Federal Reserve carries implications on the ability of hedge funds to achieve outsized returns. Specifically, via observation of historical changes in the Federal Funds Rate and the size of the Federal Reserve’s balance sheet, a proxy for the Quantitative Easing program, this study illustrates how Monetary policy influences return on investment for alternative investment vehicles. Utilizing a fixed-effect model, this study concludes that both the Federal Reserve’s Federal Funds Rate and the Quantitative Easing program have significant impact on hedge fund returns, while controlling for other fundamental changes in macroeconomic conditions such as Inflation, Industrial Production, Unemployment, and short term expected domestic economic growth.