Toeing the Informed Trading Line

Abstract

This paper investigates how personal connections facilitate informed option trading prior to corporate events. We identify person-to-person connections between hedge funds and companies before merger and acquisitions announcements and find that fund managers’ pre-announcement option holdings predict the direction and size of the acquirers’ stock return. This return predictability is more pronounced when connections form through funds’ senior officials, Ivy League networks, and MBA programs, thus highlighting the importance of fund managers’ ability to access and process private information for informed trading. For regulators, our results identify a channel for material private information dissemination between network participants.

Keywords: Informed Trading, Insider Trading, Social Networks, Hedge Funds, M&A, Options

JEL Classification: D82, G11, G12, G14, G34, Z13