Do Hedge Funds Trade on Private Information? Evidence from Syndicated Lending and Short-Selling

Abstract

This paper investigates important contemporary issues relating to hedge fund involvement in the syndicated loan market. In particular, we investigate the potential conflicts of interest that arise because of the absence of regulations relating to hedge funds’ dual holdings of loans and short positions in the equity of borrowing firms. We find evidence of possible short-selling on private information in the equity of the hedge fund borrowers prior to the public announcements of both loan originations and loan renegotiations (amendments). In addition, our results show that hedge funds are more likely to lend to highly leveraged, low credit quality firms, where access to private information is potentially most valuable and where trading on such information can lead to greater profits. Overall, our results have important implications for the current debate regarding regulation of the hedge fund industry.

Keywords: Hedge funds, short-selling, private information, syndicated loans, loan origination, loan renegotiation, loan amendment

JEL Classification: D82, G2, G38