Researchers from the University of Alabama and the University of Florida document a channel of information flow from investment banks to their prime brokerage hedge fund clients. They examine whether hedge funds make informed trades on the stocks of firms that obtain new loans from the funds’ prime brokerage services-providing banks.
They find that these connected hedge funds make abnormally large trades prior to the loan announcement. Moreover, these trades by the connected hedge funds subsequently generate superior performance compared to other trades. The outperformance is highest for trades of connected hedge funds that have high revenue generation potential for their prime brokers and amounts to 7.2% – 8.8% per annum.