Sleeping with the Enemy: Should Investment Banks be Allowed to Engage in Prop Trading?

Review of Accounting Studies, Forthcoming

64 Pages Posted: 3 Feb 2020

See all articles by Andreas Charitou

Andreas Charitou

University of Cyprus

Irene Karamanou

University of Cyprus - Department of Public and Business Administration

Multiple version iconThere are 2 versions of this paper

Date Written: December 17, 2019

Abstract

In the midst of the controversy regarding the consequences of the Volcker Rule, we examine whether conflicts of interest exist between the research and proprietary (prop) trading departments of investment banks. Consistent with the existence of a prop trading incentive, our results suggest that banks trade both ahead of and against their upgrades and downgrades for stocks not affiliated with the investment banking department and with small institutional interest. Our results are robust to a vast array of validation and sensitivity analyses, alleviating concerns that they are driven by unobserved factors. Our analysis also suggests that the global settlement, which targeted the investment banking incentive, has accentuated the prop trading incentive. Similarly, our results do not suggest that the financial crisis and the recent attention of regulators to conflicts of interest arising from prop trading have had any success in curtailing the prop trading incentive.

Keywords: Investment banking, Proprietary trading, Financial analysts, Dodd-Frank Act, Volcker Rule

JEL Classification: G20, G24

Suggested Citation

Charitou, Andreas and Karamanou, Irene, Sleeping with the Enemy: Should Investment Banks be Allowed to Engage in Prop Trading? (December 17, 2019). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3505254

Andreas Charitou

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 2 893624 (Phone)
+357 2 895030 (Fax)

Irene Karamanou (Contact Author)

University of Cyprus - Department of Public and Business Administration ( email )

1 Panepistimiou Ave.
Nicosia CY-2109
Cyprus
+357 22 893608 (Phone)
+357 22 895475 (Fax)

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