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Abstract:
Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) market under circumstances consistent with the use of non-public information by informed banks. Specifically, the information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks. Moreover the degree of advance information revelation increases with the number of banks that have lending/monitoring relations with a given firm, and this effect is robust to controls for non-informational trade. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

adverse selection, default, bank relationship, credit default swaps, asymmetric information, liquidity

Abstract:
Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) market, consistent with the occurrence of insider trading. We show that the degree of this activity increases with the number of banks that have lending/monitoring relations with a given firm, and that this effect is robust to controls for non-informational trade. Furthermore, consistent with hedging activity by informed banks with loan exposure, information revelation in the CDS market is asymmetric, consisting exclusively of bad news. We find no evidence, however, that the degree of insider activity adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

Adverse selection, default, bank relationship, credit default swaps, asset pricing

Abstract:
Insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) market under circumstances consistent with the use of non-public information by informed banks. Specifically, the information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks. Moreover the degree of advance information revelation increases with the number of banks that have lending/monitoring relations with a given firm, and this effect is robust to controls for non-informational trade. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true.

adverse selection, default, bank relationship, credit default swaps, asymmetric information, liquidity

Abstract:
This paper asks whether momentum and post-event drift are manifestations of the same underlying mechanism or whether they are separate phenomena. We find that both effects can be attributed to persistence in returns following news which affects expected earnings or earnings growth. Holding these quantities fixed, there is no momentum effect, nor is there post-event drift for our sample of events.

momentum, underreaction, post-event drift

Abstract:
Momentum effects in stock returns need not imply investor irrationality, heterogeneous information, or market frictions. A simple, single-firm model with a standard pricing kernel can produce such effects when expected dividend growth rates vary over time. An enhanced model, under which persistent growth rate shocks occur episodically, can match many of the features documented by the empirical research. The same basic mechanism could potentially account for underreaction anomalies in general.

Abstract:
Momentum effects in stock returns need not imply investor irrationality, heterogeneous information, or market frictions. A simple, single-firm model with a standard pricing kernel can produce such effects when expected dividend growth rates vary over time. An enhanced model, under which persistent growth rate shocks occur episodically, can match many of the features documented by the empirical research. The same basic mechanism could potentially account for underreaction anomalies in general.

Abstract:
This paper studies how insider trading intensity is affected by the joint effects of competition and regulation. Prior theoretical research has found that, in the absence of regulation, more insiders leads to more insider trading. We show that optimal regulation, however, features detection and punishment policies that get stricter as the number of insiders increases, giving rise to lower insider trading in equilibrium. We construct measures of the likelihood of insider activity prior to bid announcements of private equity buyouts during the period 2000-2006 and relate these to the number of financing participants. We find that suspicious stock and options activity is associated with more equity participants, while suspicious activity in bond and CDS markets is associated with more debt participants. These results may be consistent with models of limited competition among insiders, but are inconsistent with our model of optimal regulation.

asymmetric information, LBO, private equity, regulation

Abstract:
While recent research has examined the asset pricing implications of systematic liquidity risk, a more basic question remains: Why does market liquidity change over time? Economy-wide fluctuations in asymmetric information, search costs, and credit conditions all may play a part. This paper highlights another potential explanation: changes in the willingness of agents to accommodate perturbations to their equilibrium portfolio holdings. I propose a natural measure of this flexibility - essentially a shadow elasticity - which, like a shadow price, is well defined whether or not trade actually occurs in the economy. This quantity characterizes the price impact or bid/ask spread that a small trader would experience, and is an endogenous function of the underlying state variables in the economy. I compute the function for some tractable example models and uncover a rich variety of predictions about liquidity dynamics that, in some cases, appear consistent with both the levels and covariations observed in the data. The results have important implications for the pricing and hedging of liquidity risk.

Liquidity, liquidity risk, asset pricing

Abstract:
Over the last decade, financial economists have grown increasingly circumspect about the practical meaning of market efficiency due to the so-called joint hypothesis problem. In law, however, the concept has taken on an increasingly prominent role, meaning that the need for an operational definition cannot wait. We examine the meaning of market efficiency in contingent claims markets, where existing legal criteria are inappropriate. We propose a practical and economically meaningful test of efficiency applicable to such markets. The test is shown to be immune both to the joint hypothesis problem and to misspecification of the derivatives pricing model. We illustrate application of the test to an important recent case involving credit-linked notes.

Market efficiency, derivatives, litigation

Abstract:
Are securities markets more liquid when the economy is more liquid? If so, why? One possibility is that market depth depends on credit constrained intermediaries. This paper offers another explanation, which does not involve frictions or market segmentation. Measuring market illiquidity by the slope of the representative agent's demand curve for a risky asset, I show that this slope is steeper when money-like investments (or liquid balance) represent less of an economy's assets. That is because an exchange of shares for money in such a state induces greater intertemporal substitution than it does when there are more liquid balances. Thus securities' illiquidity fluctuates naturally with the level of real liquidity. This observation has important implication for understanding the causes of market fragility.

liquidity, liquidity risk, savings, asset pricing