Forecasting informed trading at merger announcements: The use of liquidity trading

Abstract

We propose a novel method of forecasting the level of informed trading at merger announcements. Informed traders typically take advantage of their knowledge of the forthcoming merger by trading heavily at announcement. They trade on positive volume or informed buys for cash mergers and negative volume or informed sells for stock mergers. In response, market makers set wider spreads and raise prices for informed buys and lower prices for informed sells. As liquidity traders trade on these prices, our vector autoregressive framework establishes the link between informed trading and liquidity trading through price changes. As long as the link holds, informed trading may be detected by measuring levels of liquidity trading. We observe the link during the −1 to +1 period for cash mergers and −1 to +5 period for stock mergers.

Citation

Abraham, R. and Harrington, C. (2009), "Forecasting informed trading at merger announcements: The use of liquidity trading", Lawrence, K.D. and Klimberg, R.K. (Ed.) Advances in Business and Management Forecasting (Advances in Business and Management Forecasting, Vol. 6), Emerald Group Publishing Limited, Leeds, pp. 37-51. https://doi.org/10.1108/S1477-4070(2009)0000006003