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Arbitrage Involvement and Security Prices

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  • Byoung-Hyoun Hwang

    (Dyson School of Applied Economics and Management, Cornell SC Johnson College of Business, Cornell University, Ithaca, New York 14853; and Korea University Business School, Korea University, Anam-dong, Seongbuk-gu, Seoul 136-701, Korea)

  • Baixiao Liu

    (College of Business, Florida State University, Tallahassee, Florida 32306)

  • Wei Xu

    (HSBC Business School, Peking University, University Town, Nanshan District, Shenzhen 518055, China)

Abstract

We propose that hedge funds more aggressively buy underpriced stocks when they are allowed to short. To test our proposition, we utilize the institutional feature in Hong Kong in virtue of which only stocks added to a special list can be shorted. Our first-stage analysis uses hedge fund holdings data and provides evidence that the emergency of shortable securities, indeed, causes hedge funds to more aggressively buy seemingly underpriced stocks. Our second-stage analysis presents evidence that hedge funds’ increased involvement in these stocks helps correct underpricing and moves prices in the direction of fundamentals. This paper was accepted by Lauren Cohen, finance.

Suggested Citation

  • Byoung-Hyoun Hwang & Baixiao Liu & Wei Xu, 2019. "Arbitrage Involvement and Security Prices," Management Science, INFORMS, vol. 67(6), pages 2858-2875, June.
    • Handle: RePEc:inm:ormnsc:v:65:y:2019:i:6:p:2858-2875
    DOI: 10.1287/mnsc.2017.2912
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    References listed on IDEAS

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    Cited by:

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    4. Tongxia Li & Tze Chuan ‘Chewie’ Ang, 2022. "Corporate vote trading in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(S1), pages 1065-1105, April.

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