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.