The Effects of Intermediary Frictions on Asset Pricing in Non-Distressed Times

Abstract

We investigate an effect of intermediary frictions on asset pricing by examining the role of buy-and-hedge intermediaries in the convertible bond market. Buy-and-hedge intermediaries are common distributors of new convertible issues and manage the trade-offs involved with the costs and benefits of hedging. We find that prices of convertible securities reflect the loan fees, trading costs, and search costs that intermediaries incur when managing their positions. Our findings demonstrate that financial intermediaries’ trading frictions are transmitted to asset prices during non-distressed times as well as times when markets are stressed.

Keywords: intermediary asset pricing, convertible bond underpricing, convertible arbitrage, hedge funds, short-selling costs

JEL Classification: G12, G23