This dissertation consists of three essays related to short selling, informed trading and market efficiency. The first essay investigates recent allegations regarding the misuse of private insider information by hedge funds prior to the public announcement of M&A deals. We analyze this issue by using a unique and comprehensive dataset which allows us to analyze the trading pattern of hedge funds around corporate mergers and acquisitions in both the equity and derivatives markets. In general, our results are consistent with hedge funds, with short-term investment horizons (henceforth, short-term hedge funds) taking advantage of private information and engaging in trading based on such information. We show that short-term hedge funds holdings of a target's shares in the quarter prior to the M&A announcement date are positively related to the profitability of the deal as measured by the target premium. In addition, we also find that the target price run-up before the deal announcement date is significantly greater for deals with greater short term hedge fund holdings. We also find evidence consistent with informed abnormal short selling and put buying in the corresponding acquirer's stock prior to M&A announcements. This is particularly evident when hedge funds take larger stakes in target firms. In addition, we show that such a strategy is potentially very profitable. We consider alternative explanations for such short term hedge fund holdings in target firms; however our results seem inconsistent with these alternative explanations but rather, seem to be consistent with trading based on private insider information. Overall, our results have important implications regarding the recent policy debate on hedge fund regulation.;This exogenous reduction in the transaction costs of option trading provides a natural experiment to investigate unresolved issues or puzzles related to option market. In this thesis we investigate two of these major issues in the second and the third essays. The first issue is related to the substitutability or complementarity between shorting in the equity market and going long in a put option of the underlying asset. The second issue is related to the violation of the no-arbitrage conditions caused by market frictions such that synthetic stock price derived from the put-call parity is not necessarily equal to its actual price in the equity market.;In the second essay, our results show that traders in the equity market (short sellers) migrate to the options market. In the third essay, we find evidence concerning the impact of reduced transaction costs in the option markets on improving financial market price efficiency by reducing the divergence between the actual observed share prices in the equity market and the fair prices implied from the option market. This suggests that the Penny-Pilot programs had a positive impact on market efficiency in both the option and equity markets.;In an attempt to increase the competitiveness and the efficiency of electronic trading on the six US option exchanges, the Securities and Exchange Commission (SEC) recently issued a new rule (the so called Penny-Pilot programs) that required a significant reduction in the tick sizes of more than 370 stocks. This required reduction in the transaction costs of option trading provides a natural experiment to investigate as yet unresolved empirical puzzles related to the option market.
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