Endogenous Limits to Arbitrage and Price Informativeness
50 Pages Posted: 13 Apr 2022 Last revised: 19 Apr 2022
Date Written: March 15, 2022
Theory suggests that traders will be more reluctant to trade on negative private information about an ongoing merger if their trading will cause the merger to be canceled. This paper provides evidence on the existence of such endogenous limits to arbitrage and it's consequence on the informativeness of prices. Using the existence of an acquirer termination fees as a proxy for the commitment not to cancel the transaction, we show that post announcement acquirer stock prices contain more firm specific information when such a commitment exists than when it does not exist. This suggest that investors with negative private information are more willing to trade on their information when managers are prevented from using this information to adjust their decisions.
Keywords: Limits to arbitrage, Termination fee, Feedback
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