Anomalies:the law of one price in financial markets_Lamount_2003 Flashcards
What is the law of one price?
LOP: If there are no transaction costs or other constraints (short selling), then identical goods must have identical prices
What are two ingredients to violation of LOP?
Some agents have to believe falsely that there are real differences between two identical goods
There have to be some impediments to prevent rational arbitrageurs from restoring equality of prices that rationality predicts
Should LOP theoretically hold in financial markets?
Yes, because arbitrageurs will immediately use the opportunity and thus eliminate price difference
What is a Closed-end country fund?
Mutual funds that issue a fixed number of shares through a single IPO to rate capital for its investments
What is an American depositary receipts (ADRs)?
Negotiable certificate issued by a bank representing shares in a foreign company traded on a local stock exchange.
What is ADR purpose as a claim to foreign non-US companies?
ADRs are claims of non-US companies that trade on US markets and are created to make it easier for US investors to own foreign companies.
What happened with ADR of Infosys, an Indian tech company trading in Bombay?
It traded at a 136% premium on the Bombay shares. THere were barriers for short-sellers.
It also offered significant diversification benefits to Americans but not Indians -> impossible to prove mispricing
What are twin shares?
Some firms have 2 types of shares with fixed claims on CF and assets of the firm.
Royal Dutch/Shell: Royal Dutch (traded in Amsterdam) shares receive 60% of earnings, while Shell (London) get the remaining 40%
What happened to Royal Dutch shares when it was not anymore in S&P 500 in 2012?
Once foreign companies were dropped from the index in 2012, Royal Dutch price premium disappeared almost immediately.
What are dual class shares and what about their difference in prices?
Two classes of shares of the same company with different voting rights usually trade at about the same price, except when there is some battle for corporate control/
What happened to premiums of Molex once dual shares were added to S&P?
Before 1990, the premium on voting shares fluctuated 0-10%; after voting shares were added to S&P, the premium rose to 49% in 2000
What is the concept of corporate spinoff?
Company seperates a part of itself into a seperate entity, with the goal of receiving a higher market valuation (belief that market has not incorporated this part of the business properly into the price)
What happens to valuation disparity (gap) after arbitraguers take the position?
The valuation disparity may widen, causing the net wealth of the arbitrageur to decline, and possible bankruptcy before the prices/spreads converge in the desired direction (noise trader risk)
Did authors find that LOP is violated?
None of the cases were so strong to violate LOP without counterarguments, but made feel that markets are not perfect.
