Hedge Funds Are Not Destabilizing

The possibility that hedge fund trading destabilizes or creates a volatile market is frequently debated. This hypothesis is in stark contrast to the traditional speculative stabilizing theory that profitable speculation must involve buying when the price is low and selling when the price is high. To test the hypothesis that hedge fund trading is destabilizing we employ a unique dataset from the U.S. CFTC on individual positions of hedge funds in a heavily traded financial futures market, the 10-year T-notes. While others have used a more aggregated version of our data, here we test, for the first known time, whether hedge funds cause, in a forecasting sense, price movements and volatility in futures markets and, therefore, destabilize the market. Our findings confirm that hedge fund trading in futures markets is not destabilizing. In particular, hedge funds trading activity reduces volatility levels.