This study considers the ‘contagion versus interdependence’ controversy between hedge funds and equity markets. We find that contagion effects break down the established interdependence between hedge funds and equity markets and that conditional return smoothing (the tendency of hedge funds to underreport losses than gains) is a driving factor of these contagion effects during crisis. These findings are obtained by linking the single equation error correction model to the factor model and then by carrying out quantile regression and the Wald–Wolfowitz runs test.
Keywords: Hedge funds; Contagion; Interdependence; Conditional return smoothing, Single equation error correction model; Factor model
