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Slow Moving Capital

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  • Mitchell, Mark
  • Pedersen, Lasse Heje
  • Pulvino, Todd

Abstract

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.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6117.

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Date of creation: Feb 2007
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Handle: RePEc:cpr:ceprdp:6117

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Related research

Keywords: capital constraint; convertible bond; frictions; hedge funds; limits of arbitrage; liquidity; merger arbitrage; risk management; valuation;

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  1. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
  2. Merton, Robert C., 1987. "A simple model of capital market equilibrium with incomplete information," Working papers 1869-87., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Viral V. Acharya & Lasse Heje Pedersen, 2004. "Asset Pricing with Liquidity Risk," NBER Working Papers 10814, National Bureau of Economic Research, Inc.
  4. Mark Mitchell, 2001. "Characteristics of Risk and Return in Risk Arbitrage," Journal of Finance, American Finance Association, vol. 56(6), pages 2135-2175, December.
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