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February 28, 2014

The SEC Should Really Start a Hedge Fund

“It’s hard to pick stocks that will go up, so most people can’t do it consistently. It’s about equally hard — probably a bit harder — to pick stocks that will go down, so most people can’t do that consistently either. But if somehow you knew in advance what banks were going to be investigated for bank-y malfeasance, or which biotech companies were cooking their books, then you could sell their stocks and avoid losses, with consistent repeatable outperformance. Who might know that sort of thing in advance?”

“The decomposition of returns earned by SEC employees suggests that the abnormal returns are earned in the sell portfolio. In particular, the 12 month ahead (252 trading days) abnormal returns, using the four factor Fama-French model as the model of expected returns, of U.S. common stocks that SEC employees buy (sell) is 0.56% (-7.97%). Hence, SEC employees’ stock purchases look no different from those of uninformed individual investors … but their sales appear to systematically dodge the revelation of bad news in the future. This fact pattern is consistent with the greater informational advantage related to potential enforcement activities that employees of a regulator are likely to enjoy over other market participants.”

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Read full Bloomberg View article here.

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