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Can the market divide and multiply? A case of 807 percent mispricing

Can the market divide and multiply? A case of 807 percent mispricing This paper documents a strong violation of the law of one price surrounding a large rights issue.Design/methodology/approachIf prices are right, the relation between the prices of shares and rights follows the outcome of a simple calculation.FindingsIn the case of Royal Imtech N.V. in 2014, prices deviated sharply and persistently from the theoretical prediction. Throughout the term of the rights, investors were buying shares at prices that were many times what they should have been given the price of the rights. Short-selling constraints in the form of high recall risk and lacking stock lending supply are the most likely explanation for the failure of arbitrage as a safeguard of market efficiency. Still, it remains remarkable that investors were buying large volumes of shares at highly inflated prices in the presence of a cheap, perfect substitute.Originality/valueThe mispricing was special not just because of its severity but also because unlike previously documented cases there was no fundamental risk and no material noise trader risk. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Behavioral Finance Emerald Publishing

Can the market divide and multiply? A case of 807 percent mispricing

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References (26)

Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1940-5979
DOI
10.1108/rbf-01-2020-0009
Publisher site
See Article on Publisher Site

Abstract

This paper documents a strong violation of the law of one price surrounding a large rights issue.Design/methodology/approachIf prices are right, the relation between the prices of shares and rights follows the outcome of a simple calculation.FindingsIn the case of Royal Imtech N.V. in 2014, prices deviated sharply and persistently from the theoretical prediction. Throughout the term of the rights, investors were buying shares at prices that were many times what they should have been given the price of the rights. Short-selling constraints in the form of high recall risk and lacking stock lending supply are the most likely explanation for the failure of arbitrage as a safeguard of market efficiency. Still, it remains remarkable that investors were buying large volumes of shares at highly inflated prices in the presence of a cheap, perfect substitute.Originality/valueThe mispricing was special not just because of its severity but also because unlike previously documented cases there was no fundamental risk and no material noise trader risk.

Journal

Review of Behavioral FinanceEmerald Publishing

Published: Mar 2, 2022

Keywords: Law of one price; Market efficiency; Mispricing; Limits to arbitrage; Short-sale constraints; G12; G14; G40

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