The impact of diversification on trading environment
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This dissertation comprises two essays on the effect of diversification on trading environment. In the first essay we study the effect of takeovers on liquidity, and in particular whether changes in scope and size of the bidder and duration of takeover negotiations affect liquidity. We finalize by investigating the relation between these changes in liquidity and announcement returns. We find that takeovers are, on average, associated with declines in spreads and spread components, and increases in depth. Spreads decline the most for non-conglomerate takeovers and takeovers that take a long time to complete. However, we find no relation to changes in adverse selection – the most likely vehicle by which scope and duration would impact liquidity. Furthermore, the decline in spreads is related to increases in volume, number of analysts following the acquirer, and number of market makers trading the acquirer. These results suggest that liquidity is improved by takeovers as a result of increased visibility and more active trading of the acquirer. Finally, we find that liquidity improvements are positively related to announcement returns. In the second essay we study the liquidity of a particular basket of securities, SPDRs (pronounced spiders), and the impact of their introduction on the S&P 500 component stocks. SPDRs are an exchange-traded fund (ETF) that mimics the performance of the S&P 500, and were the first ETF to be introduced in the US market. We find that SPDRs have lower spreads and spread components, and greater depth than an equivalent portfolio of stocks. The introduction of SPDRs had little effect on the liquidity of the underlying stocks. Relative spreads do not change, quoted depth decreases, and the adverse selection component increases, while the inventory order processing component declines.