Essays on market frictions, information and professional money management

Abstract

This dissertation is structured as three essays on professional money management from the perspectives of government policy, inside information and institutional holding. The first study uses the French Financial Transaction Tax (FTT) introduced in 2012 as an event study to check its implication on market quality. Stocks subject to the FTT experience significantly decreased turnover and increased transaction cost relative to their untaxed peers. By decomposing stocks’ bid-ask spreads into permanent versus transient components, this study finds that the bid-ask spread of taxed stocks increased in the post-FTT period relative to untaxed stocks mainly through the transient component – a common proxy for noise trading. In contrast, the permanent component of the bid-ask spread – a proxy for information content of trades – relatively decreased in the post-FTT period for taxed stocks. The second project examines the use of insiders’ trading by different categories of institutional investors. This paper finds that hedge funds tend to trade in the same direction as insiders when insider trading is likely driven by information, but do not respond to likely liquidity-driven insider trades. Mutual funds, pension funds and other institutional investors are more likely to trade in the opposite direction from insiders, acting as liquidity providers to insider trades regardless of being information or liquidity driven. A hedge fund’s ability to exploit insider trading information contributes to its performance. The third project studies the funding liquidity faced by hedge funds and the resulting implication for stocks’ excess return co-movement. Stocks’ common hedge funds ownership tends to induce higher return co-movement with each other, compared to other institutional investors. By exploring the sample in different periods, this paper shows that the effect of excess return co-movement is much stronger during tight funding periods. This study further develops a cross-stock reversal trading strategy and finds significant abnormal returns if the portfolio returns of connected stocks held in common by hedge funds has been applied as a confirming signal. In particular, this trading strategy exploiting such price pressure due to common hedge fund ownership delivers a monthly alpha of 0.3%, which reaches to 1.5% during tight funding period.