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Gambling on the stock market: the case of bankrupt companies

Listed author(s):
  • Luís Miguel Serra Coelho


    (University of the Algarve and CEFAGE)

  • Kose John


    (New York University)

  • Richard J. Taffler

    (Warwick Business School)

This paper asks whether the stocks of bankrupt firms are correctly priced, and explores who trades the stocks of these firms, and why. Our sample consists of firms that enter into Chapter 11 and remain listed on the NYSE, AMEX, and NASDAQ post-filing. We show that these stocks are heavily traded by retail investors who are also their main stockholders. We further document that these stocks have unique lottery-like characteristics, and that retail investors trade in such stocks as if they were gambling on the market. Buying and holding such securities leads, on average, to a negative realized abnormal return of at least -28% over the 12-month post-announcement period. We find that arbitrageurs are not able to exploit this market-pricing anomaly due to implementation costs, and risks that are simply too high. We thus conclude that a combination of gambling-motivated trading by retail investors and limits to arbitrage seems to lead to the anomalous results we document. Our paper thus provides a clear answer to Eugene Fama and Kenneth French’s recent question on their blog – “Bankrupt Firms: Who’s Buying?”.

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Paper provided by University of Evora, CEFAGE-UE (Portugal) in its series CEFAGE-UE Working Papers with number 2011_03.

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Length: 57 pages
Date of creation: 2011
Handle: RePEc:cfe:wpcefa:2011_03
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