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Authors:

• Veronika Pool
  Indiana University

• Nicolas P. B. Bollen
  Vanderbilt University

Recent hedge fund scandals have fueled a debate over appropriate oversight of the industry and question the ability of regulators to protect investors by preventing fraud. This paper examines whether the presence of suspicious patterns in fund returns raises the probability of subsequent fraud. We find that the patterns exist in funds prosecuted by the SEC at the same frequency as in other funds, suggesting that performance data is not useful for predicting fraud. The sensitivity of capital flow to performance, however, is significantly stronger for the former group, indicating that some investors have the ability to distinguish between the two sets of funds.