Liquidity, Frictions and Limits to Arbitrage

Paper Session

Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM

Sheraton Grand Chicago, Chicago Ballroom X
Hosted By: American Finance Association
  • Chair: Dimitri Vayanos, London School of Economics and Political Science

Flying Under the Radar: The Effects of Short-Sale Disclosure Rules on Investor Behavior and Stock Prices

Stephan Jank
,
Deutsche Bundesbank
Christoph Roling
,
Deutsche Bundesbank
Esad Smajlbegovic
,
Erasmus University Rotterdam

Abstract

This paper analyzes how newly introduced transparency requirements for short positions affect investors' behavior and security prices. Employing a unique data set, which contains both public positions above and confidential positions below the regulatory disclosure threshold, we offer several novel insights. Positions accumulate just below the threshold, indicating that a sizable fraction of short sellers avoid disclosing their positions publicly. The decision to cross the disclosure threshold appears to be persistent, with investors sticking to their secretive behavior. Short positions held by these secretive investors are associated with stronger negative returns compared to their peers, suggesting that secretive investors possess superior information. Furthermore, we document that negative information is incorporated more slowly into stock prices when a secretive investor is just below the disclosure threshold. Overall, these findings suggest that short sellers' evasive behavior in response to the transparency regulation imposes a negative externality on stock market efficiency.

The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies

Yongqiang Chu
,
University of South Carolina
David Hirshleifer
,
University of California-Irvine
Liang Ma
,
University of South Carolina

Abstract

We examine the causal effect of limits to arbitrage on ten well-known asset pricing anomalies using Regulation SHO, which relaxes short-sale constraints for a random set of pilot stocks, as a natural experiment. We find that the anomalies become substantially weaker on portfolios constructed with pilot stocks during the pilot period. Regulation SHO reduces the combined anomaly long-short portfolio returns by 77 basis points per month, a difference which survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.

Slow Trading and Stock Return Predictability

Allaudeen Hameed
,
National University of Singapore
Matthijs Lof
,
Aalto University
Matti Suominen
,
Aalto University

Abstract

The state of market returns positively predicts the size premium (or the difference in the return on small and large firms). A trading strategy that buys (sells) small firms and sells (buys) large firms following positive (negative) market return states yields large, risk-adjusted monthly profits of 1.8%, 3.0% or 4.3% when rebalanced monthly, weekly or daily. Moreover, this predictability is also present in actively traded ETFs and in recent years. We uncover that when rebalancing portfolios, institutional investors execute trades in large-cap stocks swiftly, but are slower in trading small firms, hence contributing to the predictability of size-based stock returns.

The Supply of Liquidity and Real Economic Activity

Jonathan Goldberg
,
Federal Reserve Board

Abstract

This paper identifies shocks to the supply of liquidity by dealer firms and investigates their effects on real economic activity. First, I develop a simple theoretical model of dealer intermediation; then, in a structural VAR model, I use sign restrictions derived from the theoretical model to identify liquidity supply shocks. Liquidity supply shocks that are orthogonal to information contained in macroeconomic and asset price variables have considerable predictive power for economic activity. Moreover, positive liquidity supply shocks cause large and persistent increases in real activity.
Discussant(s)
Adam Reed
,
University of North Carolina-Chapel Hill
Jeffrey Pontiff
,
Boston College
Tobias Moskowitz
,
Yale University
Tyler Muir
,
Yale University
JEL Classifications
  • G1 - Asset Markets and Pricing