Using hedge funds’ holdings of IPO stocks, we find that stocks with abnormally high hedge fund holdings, based on stock and deal characteristics, yield abnormal returns. Moreover, hedge funds are able to sell IPO stocks in a timely fashion before long-run underperforming periods start, suggesting that hedge funds possess information advantages in IPO stocks. Finally, we address the question of where hedge funds may have obtained their information advantages. Hedge funds earn higher abnormal returns in “connected” stocks when their prime brokers also serve as IPO underwriters, indicating that such connections enable hedge funds to make more informed investment decisions in IPO stocks. Received December 31, 2014; editorial decision May 27, 2017 by Editor Wayne Ferson.

We augment a simple inventory model with new features of the post-crisis regulations to offer new predictions on the effects of post-crisis regulations on the over-the-counter markets. First, the increased capital requirements of Basel III lead to an overall increase in order rejection rates of large orders. Second, and more importantly, the effects on order rejection rates depend on the risk weights used in calculating risk-weighted assets (RWAs). More specifically, the increase in order rejection rates is more severe for assets with higher risk weights, but less severe for assets with lower risk weights. In fact, for the cases of the lowest risk weights, simulations suggest that we may even see a decrease in order rejection rate. Third, the price impact of assets with higher risk weights increases, while the price impact of assets with lower risk weight decreases in the post-regulation period. Overall, our paper points to an important unintended consequence of the post-crisis regulations—the re-distribution of liquidity among assets with different risk weights assigned to them.

This paper examines transaction costs and liquidity in the index CDS market by matching intraday quotes to real-time trade reports made available through the Dodd-Frank reforms. We find that the average relative effective spread is 0.27% of price level or 2.73% of CDS spread. Dodd-Frank does affect transaction costs and liquidity. Liquidity improves after the commencement of public dissemination of OTC derivatives trades. Moreover, cleared trades, trades executed on exchange-like venues, end-user trades, and bespoke trades exhibit lower trading costs, price impact, and price dispersion. These findings improve our understanding of the OTC derivatives market that is undergoing fundamental changes.

This paper examines the impact of central clearing on the credit default swap (CDS) market using a sample of voluntarily cleared single-name contracts. Consistent with central clearing reducing counterparty risk, CDS spreads increase around the commencement of central clearing and are lower than settlement spreads published by the central clearinghouse. Furthermore, the relation between CDS spreads and dealer credit risk weakens after central clearing begins, suggesting a lowering of systemic risk. These findings are robust to controls for frictions in both CDS and bond markets. Finally, matched sample analysis reveals that the increased post-trade transparency following central clearing is associated with an improvement in liquidity and trading activity.

The credit default swap (CDS) Big Bang introduced 2 standard coupons for CDS trading. We exploit the setting of the 2 standard coupons as a natural experiment to quantify the components of the bid–ask spreads in over-the-counter markets. We find that a significant portion of the difference in the bid–ask spread between the 2 coupons is explained by the difference in funding costs. Furthermore, search intensity also explains the variation in the difference in bid–ask spread. The liquidity typically concentrates on one of the standard coupons and can suddenly switch to the other coupon. Using the sudden switch of the primary coupon, we provide further evidence to support the predictions of search-based liquidity models.

Mini options are specially catered to retail investors with limited capital for trading options on extremely high-priced securities. The coexistence of both Mini and standard options for the same underlying security provides us a novel setting to investigate whether and how small retail investors use derivatives contracts differently compared to their counterparts. First, we find that the Mini option investors are more subject to constraints of limited attention. Specifically, Mini option investors trade more intensively near market opens, and their trading activities are more heavily influenced by attention-grabbing events and attention-distracting events. Second, we document that Mini option investors’ trading is more likely to be driven by market sentiment than standard option investors. Third, the trading performance of Mini option investors is also worse than that of standard option investors, with less positive intraday returns and more negative overnight returns.

We use the advent of new credit default swap (CDS) trading conventions in April 2009—the CDS Big Bang—to study how a shock to funding liquidity impacts market liquidity. After the Big Bang, traders are required to pay upfront fees to execute CDS transactions, with the size of the fees depending on the level of CDS spreads. While CDS bid-ask spreads decline in aggregate after the Big Bang, they do so less for contracts that require larger fees. Furthermore, the funding effect is stronger for smaller and riskier firms and for noncentrally cleared contracts. The effect also becomes stronger after Deutsche Bank's exit.