Working Paper: CEPR ID: DP7212
Authors: Johan Hombert; David Thesmar
Abstract: We present a model where arbitrageurs operate on an asset market that can be hit by information shocks. Before entering the market, arbitrageurs are allowed to optimize their capital structure, in order to take advantage of potential underpricing. We find that, at equilibrium, some arbitrageurs always receive funding, even in low information environments. Other arbitrageurs only receive funding in high information environments. The model makes two easily testable predictions: first, arbitrageurs with stable funding should experience more mean-reversion in returns, in particular following low performance. Second, this larger mean-reversion should be lower, if many other funds have stable fundings. We test these predictions on a sample of hedge funds, some of which impose impediments to withdrawal to their investors.
Keywords: arbitrageur; capital structure
JEL Codes: G11; G14; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Guaranteed funding (H81) | Greater mean reversion in returns after low performance (C22) |
| Larger fraction of arbitrageurs with guaranteed funding (G19) | Less pronounced overperformance of arbitrageurs (G19) |
| Guaranteed funding (H81) | Less underpricing in low information states (D89) |