Sonderforschungsbereich/Transregio 15 · www.sfbtr15.de

We estimate an investors ’ demand model for hedge funds to analyze the potential im-pact of leverage limits in the industry. Our estimation results highlight the importance of heterogeneous investor preference for the use of leverage, i.e., 20 % of investors prefer leverage usage while others do not. We then conduct a policy simulation in which reg-ulators put a cap on allowable leverage, as proposed by the Financial Stability Board in 2012. Simulation results suggest that the 200 % leverage limit would lower the total demand (assets under management) for hedge funds by 10%. In particular, the regula-tion would lead to lower investments in highly leveraged funds and to lower investment