...Limited Arbitrage in Equity Markets MARK MITCHELL, TODD PULVINO, and ERIK STAFFORD* ABSTRACT We examine 82 situations where the market value of a company is less than its subsidiary. These situations imply arbitrage opportunities, providing an ideal setting to study the risks and market frictions that prevent arbitrageurs from immediately forcing prices to fundamental values. For 30 percent of the sample, the link between the parent and its subsidiary is severed before the relative value discrepancy is corrected. Furthermore, returns to a specialized arbitrageur would be 50 percent larger if the path to convergence was smooth rather than as observed. Uncertainty about the distribution of returns and characteristics of the risks limits arbitrage. THIS PAPER EXAMINES IMPEDIMENTS to arbitrage in equity markets using a sample of 82 situations between 1985 and 2000, where the market value of a company is less than that of its ownership stake in a publicly traded subsidiary. These situations suggest clear arbitrage opportunities, yet, they often persist, and therefore provide an interesting setting in which to study the risks and market frictions that prevent arbitrageurs from quickly forcing prices to fundamental values. Arbitrage is one of the central tenets of financial economics, enforcing the law of one price and keeping markets efficient. In its purest form, arbitrage requires no capital and is risk free ~see Dybvig and Ross ~1992!!. By simultaneously selling...
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...Wahe Guru Satnaam Case Report Structure: I. Case background (0.5 mark) • Create a table with the key dates, events, and decisions to be made. |Keys Date |Events |Decisins to be made | |1998 |Closing of seven retail store of creative computers and |Development of Ubid Website | | |selling of factories excess and other reburised goods through| | | |internet | | |6/07/1998 |Selling of 20% of Ubids equity in Intial public Offerings and|Increasing the market awarness about Ubid | | |remaining 80% to be dustributed among the share holders | | |3/12/1998 |Ubid Intial Public Offerings took place |Sold 1.817 million share at $15 | |4/12/1998 |Ubid recognised as publicly traded company |Market Capitalization | |9/12/1998 |Elena Kings first investment as a hedge Manager |To invest the funds in appropriate internet company for | | | ...
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...Course Number: FINA 6278 - MSF Program 11 / 07 / 2012 Course title: Financial Theory and Research (Part 1 – Financial Markets and Asset Pricing) Team Member: Haotian Lin; Nan Bai; Wenyi Gu; Yibo Zang Summary Standard finance (modern portfolio theory), compared with Behavioral finance, is no longer modern: dating back to the late 1950s modern portfolio theory was developed (Statman 2008) Behavioral finance offers alternative explanation for investors and markets. Behavioral finance, which has been a controversial subject and is becoming more widely accepted, is finance from a broader social science perspective including psychology and sociology (Shiller 2003). Behavioral finance helps identify the financial market’s inefficient reaction to public information, which cannot be explained by traditional financial models with assumptions such as expected utility maximization, rational investors, and efficient markets (Ritter 2003; Statman 2008). Statman (2008) compares “normal” investors and rational investors by pointing out the difference that normal investors are reluctant to realize losses since normal investors are affected by cognitive biases and emotions. Statman also compares Behavioral Portfolio Theory and Markowitz mean-variance theory. Another comparison made by Statman is between Behavioral Asset Pricing Model (BAPM) and capital asset pricing model (CAPM), stating that the asset pricing model of standard finance is moving away from CAPM toward Fama...
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...Characteristics of risk and return in risk arbitrage Purpose of this paper is to analyze 4750 mergers from 1963 to 1998 to characterize the risk and return in risk arbitrage. After the announcement of a merger or acquisition the target company stock typically trade at discount to the price offered by the acquiring company. The difference is known as arbitrage spread, called merge arbitrage referred to an investment strategy making profit from this spread. If merger is successful the arbitrageur will capture the arbitrage spread, if not he will lose money. Previous papers have concluded with that investors make money from this strategy. These finding suggest that financial market are not efficient in the pricing of firms. There are other to explanations one is that transaction and other practical limitations prevent investors from realizing these extraordinary returns. The second it that risk arbitrageurs receive a risk premium to compensate the risk of deal failure. Effect of transaction cost Construct to different series of risk arbitrage returns. The first series is calendar time value weighted average of return to individual mergers ignoring transaction cost and other practical limits. The second portfolio return series mimics the return from hypothetical risk arbitrage index manager. It includes transaction cost, consisting both broker commission and price impact associated with trading less than perfectly liquid securities. And include also practical constraint. When...
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...The theoretical price of the MMI March ’86 futures contract is(Assume 23 days): PV[S(T)]=S(t)-PV(3.41)=311.74-3.41*e^(-0.068*23/365)=308.34 F(t,T)=308.34*e^(0.068*23/365)=309.67 Theoretical price= 309.67 Market future price= 313.55 Spot price today=311.74 Assume that Jim is subject to a $5,000,000 position limit: Cash Flow at t Cash Flow at T Borrow money 311.74*110%=342.91 -342.91*e^(0.068*23/365)= -344.38 Margin payment 311.74*10%=-31.17 31.17 Buy underlying -311.74 S(T)+3.41*(311.74/1374.50)=S(T)+0.77 Short future 0 313.55-S(T) Total 0 313.55-344.38+31.17+0.77=1.11 Since Jim is subject to a $5,000,000 position limit, he will back 5000000/311.74=16039Units. Thus, he can make profit from this arbitrage opportunity about 16039*1.11=$17803.29. The rate of return Jim expects to earn is: (17803.29-transcation cost)/5,500,000= (17803.29*99.75%)/5,500,000=0.32% People who want to protect their assets against the risk of interest rate fluctuation. People who want to get arbitrage opportunity. People who are speculator. When we comparing the differences between the theoretical price and the market future price, we could exploit the arbitrage opportunity depend whether the difference is positive or negative. When the theoretical price is lower than the market future price, we could buy underlying at low price and short sell the future contract. Compare to the MMI, S&P 500 will have a higher likelihood of having a counter...
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...Chapter 18 A SURVEY OF BEHAVIORAL FINANCE ° NICHOLAS BARBERIS University of Chicago RICHARD THALER University of Chicago Contents Abstract Keywords 1. Introduction 2. Limits to arbitrage 2.1. Market efficiency 2.2. Theory 2.3. Evidence 2.3.1. Twin shares 2.3.2. Index inclusions 2.3.3. Internet carve-outs 3. Psychology 3.1. Beliefs 3.2. Preferences 3.2.1. Prospect theory 3.2.2. Ambiguity aversion 4. Application: The aggregate stock market 4.1. The equity premium puzzle 4.1.1. Prospect theory 4.1.2. Ambiguity aversion 4.2. The volatility puzzle 4.2.1. Beliefs 4.2.2. Preferences 5. Application: The cross-section of average returns 5.1. Belief-based models 1054 1054 1055 1056 1056 1058 1061 1061 1063 1064 1065 1065 1069 1069 1074 1075 1078 1079 1082 1083 1084 1086 1087 1092 ° We are very grateful to Markus Brunnermeier, George Constantinides, Kent Daniel, Milt Harris, Ming Huang, Owen Lamont, Jay Ritter, Andrei Shleifer, Jeremy Stein and Tuomo Vuolteenaho for extensive comments. Handbook of the Economics of Finance, Edited by G.M. Constantinides, M. Harris and R. Stulz © 2003 Elsevier Science B.V All rights reserved . 1054 5.2. Belief-based models with institutional frictions 5.3. Preferences N. Barberis and R. Thaler 6. Application: Closed-end funds and comovement 6.1. Closed-end funds 6.2. Comovement 7. Application: Investor behavior 7.1. 7.2. 7.3. 7.4. 7.5. Insufficient diversification Naive diversification Excessive trading The selling decision...
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...Seagate share. If all MBA do this the price of Seagate share will rise and price of Veritas share will fall and they will converge to one price and there will be no opportunity of arbitrage. 2.The price of both the company is different as law of one price is violated as high tax for transaction limits the arbitrage opportunity allowing difference in stock price to exist. The law of one price states that same asset cannot trade at different price. Both the companies are into to relatively different business, Seagate is into hardware industry and Veritas in software industry. As hardware industry in which Seagate is very volatile and it requires high investment due to which it was not favoured by the investors and analysts which is driving down the price. The vertical integration it carried out brought about high R&D and capital expenses like high manufacturing cost. This caused decrease in the value of Seagate stock as it had high fixed cost so in downturn it is difficult to pay off high fix cost. Only cost associated with the software industry is the investment into human capital which fluctuation is not much in comparisons to the market in which Seagate was, moreover software market was growing market and investors preferred investing in it. Moreover as high tax for transaction limits the arbitrage opportunity, thus share prices depends on the law of supply and demand, as prices are set where the number of shares demanded equals the number of shares supplied. ...
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...exchange data centers. HFT – defined by trading where speed matters. Subset of HFT by TMX program – ELP (electronic liquidity provider) Today, typical high frequency systems are interpreting and reacting to market data in microseconds. High Frequency Group | Specific Strategy | Market making | *passive rebate arbitrage, exchanges provide incentives to liquidity providers by paying for passive order flowHigh frequency trading strategies that involves placing an order to sell (or offer) or buy a limit order (or bid) in order to earn a bid-ask spread. | | Ticker tape trading – by observing flow of quotes, high frequency machines are able to extract information that has not yet crossed the news screens. Since all quote and volume information is public, fully complaint with regulatory laws | Latency Arbitrage | Interlisted arbitrage – strategy that attempts to buy and sell the same security btw. domiciles. Eg. buying Potash corp in Canada and selling it in the U.S.Intra-listed arbitrage – strategy that attempts to buy and sell the same security btw. domestic marketplaces. Eg. Buying POT on BATS and selling it on NYSE | Information Arbitrage | Index arbitrage – strategy that attempts to profit from mispricing btw. the various forms of a tradable index. ETF arbitratge – ETF traded against either the basket of stocks or future or both | Momentum | This strategy attempts to predict over a very short period of time where the stock will trade. The profitability relies solely...
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... 60.00 50.50 45.00 x Number of BT shares received 1.30 1.30 1.30 Value of consideration received 78.00 65.65 58.50 - Basis in MCI stock (62.00) (62.00) (62.00) Gain / (Loss) on Long Position 16.00 3.65 (3.50) Gain / (Loss) on Short Position: Price of BT at time of short sale 50.50 50.50 50.50 - Market value at merger completion 60.00 50.50 45.00 (9.50) 0.00 5.50 x Number of BT shares shorted 1.30 1.30 1.30 Gain / (Loss) on Short Position (12.35) 0.00 7.15 Total Gross Spread at Merger Completion 3.65 3.65 3.65 Source: Note on Risk Arbitrage No matter at what prices the deal closed, merger arbitrageurs are be able to lock-in a risk-free profit. And the only risk of the merger arbitrage is the completion risk. MCI & BT Controversy The two companies were expected to gain the benefit from global communication merger by using each other competency; such as, a large multinational customer base in MCI and the local market expertise in BT. To merge the new global communication company, BT agreed to offer .54 of American Depository Share (ADSs) for each MCI share, plus $6 cash per MCI shares, and also gave a dividend with a total value of $3.6 billion. However, the market and economic condition had been changed, so the original term had to be revised, resulting in less appealing to MCI’s shareholders. The new terms were that each...
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...American Finance Association Limited Arbitrage in Equity Markets Author(s): Mark Mitchell, Todd Pulvino, Erik Stafford Source: The Journal of Finance, Vol. 57, No. 2 (Apr., 2002), pp. 551-584 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2697750 Accessed: 08/01/2010 15:26 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=black. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Blackwell Publishing and American Finance Association...
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...2003 3:04 PM Economy and Society Volume 32 Number 3 August 2003: 349–380 Long-Term Capital Management and the sociology of arbitrage Donald MacKenzie Abstract Arbitrage is a key process in the practice of financial markets and in their theoretical depiction: it allows markets to be posited as efficient without all investors being assumed to be rational. This article explores the sociology of arbitrage by means of an examination of the arbitrageurs, Long-Term Capital Management (LTCM). LTCM’s 1998 crisis is analysed using both qualitative, interview-based data and quantitative examination of price movements. It is suggested that the roots of the crisis lay in an unstable pattern of imitation that had developed in the markets within which LTCM operated. As the resulting ‘superportfolio’ began to unravel, arbitrageurs other than LTCM fled the market, even as arbitrage opportunities became more attractive, causing huge price movements against LTCM. Three features of the sociology of arbitrage are discussed: its conduct by people often personally known to each other; the possibility and consequences of imitation; and the limits on the capacity of arbitrage to close price discrepancies. It is suggested that by 1998 imitative arbitrage formed a ‘global microstructure’ in the sense of Knorr Cetina and Bruegger. Keywords: arbitrage; economic sociology; imitation; Long-Term Capital Management (LTCM); globalization; risk. Introduction Of all the contested boundaries...
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...Content Behavior Biases discussed in the article 2 Other behavior biases and empirical challenges 2 Lose aversion 2 Representativeness 3 Conservatism 3 Herd behavior 4 Limits to arbitrage 5 Weak-form efficiency. 5 Semi-strong form efficiency 6 Strong-form efficiency 6 Cross country and market settings difference 6 Appendix 8 References 13 Behavior biases discussed in the article The behavior biases that have been discussed are over-confidence and over-optimism. Those two biases lead investors to overestimate their knowledge, understate the risks and exaggerate their ability to control the situation and hence to trade excessively. Overconfidence about certain signals may cause overreaction and hence phenomena such as the book/market effect and long-run reversals whereas self-attribution allows prices to continue to overreact, creating momentum. In the longer-run there is reversal as prices revert to fundamentals. Other behavior biases and empirical challenges First of all, it is impractical to claim that people in general and investors in particular are fully rational. Several biases contribute to the irrationality. Loss aversion People don’t look at the levels of final wealth they can attain but at gains and losses relative to some reference points. They tend to avoid actions that could create discomfort over prior decisions, even though those actions may be in the individual’s best interest. Researchers have showed evidence of investors’ reluctance to sell losing positions...
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...In finance, risk is defined as the likelihood that we will receive a return on an investment that is different from the return we expect to make. There is a trade-off between risk and expected return. Risk in investment has to be viewed in the marginal investors’ perspectives who set the stock prices. ↕ The objective in corporate finance is the maximization of firm value and stock price. Equity Risk and Expected Return Defining the risk In addition to the expected return of an investment, investors must consider: • Variance (and standard deviation) – the spread of the actual returns around the expected return. The greater the deviation of the actual returns from the expected return, the greater the variance. • Skewness – the bias toward positive or negative returns. For example, if a distribution has a higher probability of large positive returns than the large negative returns, it is called a positively skewed distribution. • Kurtosis – the shape of the tails of the distribution. Fatter tails lead to higher kurtosis, indicating that there is a tendency of the price if this investment to jump in either direction. If the underlying distribution of returns is normal distribution, the investors only have to worry about the expected return and variance. ↑ In practice, the expected return and variance are most likely estimated using past returns rather than future returns. The assumption made when using historical variance is that past return distributions...
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...Barings Bank and Nick Leeson Introduction I would like to present the case of Barings Bank, one of the most famous histories in the world when one man led to the bankruptcy the oldest British bank. Barings collapsed on February 26, 1995, due to the activities of one trader, Nick Leeson, who lost almost $1.4 billion. The loss was caused by a large exposure to the Japanese stock market, which was achieved through the futures market. Leeson, the chief trader for Barings Futures in Singapore, had been accumulating positions in stock index futures on the Nikkei 225, a portfolio of Japanese stocks. As the market fell more than 15 percent in the first two months of 1995, Barings Futures suffered huge losses, which were made even higher due to the sale of options, which implied a bet on a stable market. As losses mounted, Leeson increased the size of the position, in a stubborn belief he was right. Finally, on 25 February 1995 he walked away, when he realized that bank was unable to make the cash payments required by the exchanges. Later, he sent a fax to his superiors, offering “sincere apologies for the predicament that I have left you in.” Nick Leeson had totally wiped out the venerable 233-year-old Baring Investment Bank, which proudly counted Queen Elizabeth as a client. He left behind huge liabilities totaling $1.4 billion, more than the entire capital and reserves of the British institution. This situation - and a similar scam at the New York branch of Japan's Daiwa Bank in October...
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...2011 FRM EXAM TRAINING SYLLABUS PART I Introduction to Financial Mathematics 1. Introduction to Financial Calculus a. Variables – Discrete and Continuous b. Univariate and Multivariate Functions – Dependent variable and Independent variable c. Physical representation of a function d. Linear and Non-Linear functions e. Limits of a function f. The number e and Natural Logarithm g. Differential Calculus – Differentiation, Interpretation - Slope of a tangent, using derivatives to calculate function values and deltas. Linear functions - 1st order derivative. Non-linear functions – 1st and higher order derivatives, interpretations and usage. Rules of derivatives. h. Functions – Differentiation and Taylor Series Expansion i. Introduction to Partial Derivatives j. Introduction to Integral Calculus 2. Introduction to Bond Mathematics a. Finance and the Time Value of Money b. Concept of Zero Coupon (Discount) Bonds and Coupon Bonds. c. Bond Characteristics d. Bond Types – Fixed Rate, Floating Rate, Inverse Floater Rate, etc. e. Interest Rates – Discrete and Continuous Compounding f. Bond Pricing – using ZCYC or YTMC with discrete compounding or continuous compounding g. Difference between bond coupon rate and bond yield h. Calculating Bond Yield (YTM, CY, MMY, ZCY/Spot, Par Yield, etc.) i. Price Yield Relationship Introduction to Financial Statistics and Econometrics 1. Introduction to Financial Statistics a. Frequency distributions b. Measures of Central Tendency/Location (Mean/Mode/Median)...
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