Synchronized Arbitrage and the Value of Public Announcements
Abstract (Via SSRN)
This paper tests the idea that arbitrageurs use public announcements as a synchronizing signal. I find that firms publicly identified by hedge fund managers as being overvalued underperform their respective benchmarks by 324 to 376 basis points per month, during the 24 months subsequent to the public announcement. In contrast, firms identified by managers as being undervalued do not overperform their benchmarks. I find evidence of coordination among arbitrageurs through an increase in post-event short selling and changes in funds’ derivative positions. Finally, I find that the long-short return disparity cannot be resolved by common explanations, such as varying manager skill, short sales constraints, analyst downgrades or slow information diffusion, but is rather derived from managers’ idiosyncratic ability to predict future accounting deficiencies and negative earnings news.