An information-based model of target stock price runup in the market for corporate control

Matthew Brigida, Jeff Madura and Ariel Viale

Quantitative Finance, 2014, vol. 14, issue 6, 1019-1030

Abstract: The stock price runup of target firms in the market for corporate control has been anecdotally attributed to inside trading. Moreover, the empirical merger and acquisitions literature documents a time-varying level and duration of the stock price runup of target firms. Using a market microstructure approach, we model stock price runup as a stochastic process that shifts between a random walk without drift and a predictable process dependent on a parsimonious set of state variables. Consistent with the market microstructure literature, predictability in prices can be exploited only by the informed trader. The model is capable of explaining the complex stylized facts observed in stock price runup. It is also consistent with the merger wave literature, as we find that capital liquidity, economic growth, and market valuations drive the complex dynamics of stock price runup.

Date: 2014
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DOI: 10.1080/14697688.2012.749356

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