How Inelastic Are Equity Markets Globally?
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For financial markets to properly function, market participants need to trust that other traders do not have access to inside information. This paper documents the transmission of inside information regarding future M&A deals in Manhattan from investment banks to mutual funds. We use detailed data on all taxi rides in New York City to create a measure of meetings between investment banks and mutual funds. We find that when mutual funds meet more frequently with a bank in a quarter, those funds are more likely to purchase the stock of a M&A target that the bank is advising in the quarter of the deal’s announcement. Our results suggest that investment bank employees share information with mutual funds which enables those funds to profitably trade in advance of M&A announcements. These results provide a rationale for mutual funds clustering near investment banks in Manhattan.
Two privately-informed agents must take a joint action without resorting to side-payments. Size and location of the support of each agent’s private type (their preferred action) determine the degree of conflict. Under high conflict, it is too costly to elicit agents’ information, which leads to an optimal constant allocation. Delegation arises endogenously when there is conflict and asymmetry in the amount of private information or bargaining power. The agent with more private information dictates the allocation within some bounds. When supports overlap, information is shared and sometimes ex-post inefficient actions are optimally taken. Welfare relative to the first- best is non-monotone in conflict. Our model has implications for the design and flow of information within an organization. It can also help us understand the role of culture and homophily within an organization.
We study the role of regulatory mandates, or investment restrictions, in shaping the distribution of risk taking and market power among large non-bank financial institutions. Institutions trade to hedge risks, but market concentration leads to constrained-inefficient risk sharing even when all institutions can access complete financial markets. Imposing mandates on a subset of investors redistributes market power and can further hamper risk sharing. Optimal market-wide mandates, in contrast, can improve risk sharing and welfare through general equilibrium forces, and we characterize their properties. Our findings suggest that broad coverage is critical for implementing effective portfolio constraints on non-bank financial institutions.
In opaque markets plagued by asymmetric information, such as interbank and OTC markets, firms borrow from many lenders at once and individual contracts are not observable to other lenders. We identify a novel information externality in a model based on this type of setting. Due to adverse selection, lenders use their private information to adjust the size of loans rather than the prices they offer to borrowers. Each lender’s individual rationing decision creates an information externality that raises other lenders’ profits, even though information is not shared and lenders compete with each other. The model provides a microfoundation for adverse selection-based peer monitoring in opaque credit markets and has implications for their optimal structure.