Do we need the Dutch grey market for stocks?

When-issued trading concerns transactions in securities that have not yet been issued. Those often take place in a so-called 'grey market', in which all contracts are conditional on the issuance of the security. In a recent TILEC discussion paper, TILEC member Luc Renneboog and co-author Christophe Spaenjers (Tilburg University) investigate the Dutch 'phantom market' for when-issued shares prior to stock splits and initial public offerings (IPO), using a unique, hand-collected dataset. They find that market makers are more likely to set up a when-issued market
after a stock split announcement when the number of expected transactions is large and the expected costs are low. On the basis of when-issued and regular share closing prices, they calculate that when-issued securities trade at a small but economically significant premium (of on average about 0.60%) over the regular shares during a limited period before the effective date of the stock split (after correcting for the time value of money). This when-issued premium disappears in the last days prior to the stock split. In the case of when-issued trading in the run-up to an IPO, the prices paid in the grey market are in line with the first day closing prices. Overall, those results confirm that pre-issuance trades are highly informative.