The Economic Consequences of Hedge Fund Regulation: An Analysis of the Effect of the Dodd-Frank Act

This paper exploits registration data administered by the Securities and Exchange Commission to examine the effect of the Dodd-Frank Act on profitability, risk-taking, and capital formation in the hedge fund industry. The data show that after the act was implemented, there was a significant decline in investors’ profitability that can be at least partially attributed to direct compliance costs. However, compliance costs do not fully explain the results: part of the decline seems to be driven by collateral effects of compliance, particularly the diversion of managerial attention from core business activities and/or adjustments to financial valuation or reporting practices. The data also show that risk-taking did not change significantly and that although managers closed funds and launched fewer funds in response to the law, this behavior did not result in lower assets under management.