Petri Jylha
Aalto University

Abstract

Hedge funds commonly misreport returns by overstating their reported performance. We study the conditions that affect hedge funds managers propensity to misreport and the effects of misreporting on performance measurement. First, misreporting is most prevalent in young funds, in funds that have strong flow-performance relation, and during months of positive capital flows. These empirical findings are consistent with a simple model where hedge fund managers have two motives to misreport returns: attraction of larger capital flows in the future and wealth transfer from the new investors to the old investors in the fund. Second, misreporting smooths returns, decreases the estimates of risks, and increases estimates of risk-adjusted returns.