Short Selling Bans and Market Liquidity Around the World: Evidence from the 2007-09 Crisis

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2007-2009 Crisis

Marco Pagano, Università di Napoli Federico II
Alessandro Beber, University of Amsterdam

Most stock exchange regulators around the world reacted to the 2007-2009 crisis by imposing bans or regulatory constraints on short-selling. We use the large amount of evidence generated by these regime changes to investigate their effects on liquidity, price discovery and stock returns. Since bans were enacted and lifted at different dates in different countries, and in some countries applied to financial stocks only, we identify their effects with panel data techniques on daily data for 30 countries, controlling for time-invariant stock characteristics by fixed effects, as well as for changes in volatility and other aggregate risk factors.

Short selling restrictions affect the price formation process and thus have the potential to change valuations. This study will examine how bans and constraints on short-selling in various countries affect characteristics of market that interest investment managers. Since many investment managers employ short-selling strategies, the public policy implications of the proposed research should be of particular interest to them.

Do Institutional Investors Have an Ace up Their Sleeves? Evidence from Confidential Filings of Portfolio Holdings

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Vikas Agarwal, Georgia State University
Wei Jiang, Columbia University
Yuehua Tang, Georgia State University
Baozhong Yang, Georgia State University

This paper studies the holdings by institutional investors that are filed with a significant delay through amendments to Form 13F and that are not included in the standard 13F holdings databases (the “confidential holdings”). We find that asset management firms (hedge funds and investment companies/advisors) in general, and institutions that actively manage large and risky portfolios in particular, are more likely to seek confidentiality. The confidential holdings are disproportionately associated with information-sensitive events such as mergers and acquisitions, and include stocks subjected to greater information asymmetry. Moreover, the confidential holdings of asset management firms exhibit superior risk-adjusted performance up to four months after the quarter end, suggesting that these institutions may possess short-lived information. Our study highlights the tension between the regulators, public, and investment managers regarding the ownership disclosure, provides new evidence in the cross-sectional differences in the performance of institutional investors, and highlights the limitations of the standard 13F holdings databases.

Many investment managers use Form 13F institutional position reports when formulating their investment strategies, when predicting implementation costs, and when planning their trades. Block brokers also use this information to help them identify traders who would likely take the other side of a large order. Finally, most institutional managers have to make Form 13F reports. This proposed study should provide results that will better help managers understand the information content of these reports and the specific reasons why some managers defer reporting confidential holdings.

Anatomy of Trading and Liquidity in the Credit Default Swaps Market

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Viral V. Acharya, New York University
Robert Engle, New York University

Trading in the multi-trillion dollar credit default swaps (CDS) market has remained a mystery to most due to lack of available data. We propose to demystify this market by employing a unique data set of all trades with anonymized counterparty information at daily level from January 2007 to date of North American single-name CDS. In particular, we seek to explain for the CDS market the extent and nature of trading (by whom – dealer or buy-side players and how concentrated) and its liquidity measured in different ways using number of trades, volume, price dispersion and price impact. Our primary economic inquiry is to document and understand the time-series variation in CDS market liquidity, especially the change from prior to the crisis (pre-August 2007) to during the crisis, with a focus on significant events of stress to the CDS markets such as 9th August 2007 (money market “freeze”), 14th March 2008 (the collapse of Bear Stearns) and 15th September 2008 (Lehman Brothers’ failure), and employing equity and bond market liquidity changes as controls for trading stress unrelated to the CDS markets.
The CDS market has grown very large and quite controversial without much public understanding of the characteristics of liquidity in this market. As the purest market for bankruptcy-related credit risk, fixed income investment managers often trade in it or extract information from its prices. The proposed work will examine previously unavailable data to provide characterizations of liquidity in the CDS market.

On Tournament Behavior in Hedge Funds: High Water Marks, Managerial Horizon, and the Backfilling Bias

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George O. Aragon, Arizona State University
Vikram Nanda, Georgia Institute of Technology

We analyze the risk choices by hedge funds that perform poorly, relative to other funds and in absolute terms – and test predictions on the extent to which these decisions are related to the fund’s incentive contract, investment horizon and dissemination of performance information. We find that “tournament” behavior is more prevalent in the (backfilled) period when funds may be at an incubation stage, before they start voluntarily reporting to a database. Excluding backfilled data, we find that variance shifts depend on absolute rather than relative fund performance. Consistent with theoretical arguments, the propensity for losing funds to increase risk is significantly weaker among those that tie the manager’s incentive pay to the fund’s high-water mark – suggesting a possible benefit from such incentive structures – and among funds that face little immediate risk of closure. Overall, the combination of factors such as reporting performance to a database, high-water mark provisions, and low risk of fund closure appear to make poorly performing funds more conservative with regard to risk-shifting.
The asymmetric incentive compensation arrangements that characterize many hedge funds are widely thought to cause these funds to increase risk exposure when performing poorly. The proposed research will examine the effects on risk-taking behavior of other characteristics of the compensation contract. The results should be of particular interest to investment sponsors who employ these contracts.

Attention Allocation over the Business Cycle: Evidence from the Mutual Fund Industry

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Marcin Kacperczyk, New York University
Laura Veldkamp, New York University
Stijn Van Nieuwerburgh, New York University

The invisibility of information precludes a direct test of attention allocation theories. To surmount this obstacle, we develop a model that uses an observable variable – the state of the business cycle – to predict attention allocation. Attention allocation, in turn, predicts aggregate investment patterns. Because the theory begins -and ends with observable variables, it becomes testable. We apply our theory to a large information-based industry, actively managed equity mutual funds, and study its investment choices and returns. Consistent with the theory, which predicts cyclical changes in attention allocation, we find that in recessions, funds’ portfolios (1) covary more with aggregate payoff-relevant information, (2) exhibit more cross-sectional dispersion, and (3) generate higher returns. The results suggest that some, but not all, fund managers process information in a value-maximizing way for their clients and that these skilled managers outperform others.

Predicting active performance returns is of particular interest to investment sponsors and investment managers. The proposed study introduces a model that predicts that investment managers who have the potential to gather macroeconomic insights into the future allocate more attention to these skills when they are more likely to be rewarded. These insights will help investment sponsors better evaluate their managers. They also will help investment managers better allocate the research resources.