Gambling on the stock market: the case of bankrupt companies

Luís Miguel Serra Coelho ()
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Luís Miguel Serra Coelho: School of Economics - University of the Algarve and CEFAGE
Authors registered in the RePEc Author Service: Kose John

CEFAGE-UE Working Papers from University of Evora, CEFAGE-UE (Portugal)

Abstract: 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?”

Keywords: Chapter 11 filing; Post-bankruptcy trading; Gambling; Lottery stocks; Limits to arbitrage; Retail investors. (search for similar items in EconPapers)
JEL-codes: G14 G33 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2011
New Economics Papers: this item is included in nep-bec and nep-cfn
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:cfe:wpcefa:2011_03

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