Suspicious Patterns in Hedge Fund Returns and the Risk of Fraud
Review of Financial Studies, forthcoming 2012

Nicolas P.B. Bollen and Veronika Krepely Pool

Recent cases of hedge fund fraud have caused large losses for investors and have fueled the debate regarding the ability of regulators to oversee the industry. This paper proposes a set of performance flags, based on suspicious patterns in returns, as indicators of a heightened risk of fraud. We collect a sample of hedge funds charged with legal or regulatory violations and find that funds charged with misappropriation, overvaluation, misrepresentation, or Ponzi schemes trigger the performance flags at a higher frequency than other funds.