DP6117 Slow Moving Capital
|Author(s):||Mark Mitchell, Lasse Heje Pedersen, Todd Pulvino|
|Publication Date:||February 2007|
|Keyword(s):||capital constraint, convertible bond, frictions, hedge funds, limits of arbitrage, liquidity, merger arbitrage, risk management, valuation|
|JEL(s):||G1, G12, G14|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6117|
We study three cases in which specialized arbitrageurs lost significant amounts of capital and, as a result, became liquidity demanders rather than providers. The effects on security markets were large and persistent: Prices dropped relative to fundamentals and the rebound took months. While multi-strategy hedge funds who were not capital constrained increased their positions, a large fraction of these funds actually acted as net sellers consistent with the view that information barriers within a firm (not just relative to outside investors) can lead to capital constraints for trading desks with mark-to-market losses. Our findings suggest that real world frictions impede arbitrage capital.