Week 1 - Lamont, O. A., and Thaler, R. H. (2003). Can the market add and subtract? Mispricing in tech stock carve-outs. Journal of Political Economy, 111(2), 227–268.

Question 1

What is an Equity carve-out (partial public offering) ?

Answer 1

IPO for shares, usually minority stake, in a subsidiary company; partial divestiture of a business unit.

Question 2

What is a Spinoff?

Answer 2

the parent firm gives remaining shares in the subsidiary to the parent’s
shareholders; the parent distributes the entire ownership interest in the subsidiary as
a stock dividend to existing shareholders and no money changes hands.

Question 3

What is a Stub?

Answer 3

is the residual security that is left over after removing the carve-outed subsidiary from the parent security.

the pricing of the parent company in respect to the subsidary (spinoff)

If the stub is negative it indicates a groos indication of misspricing. When this stub is negative, it
means that the parent company is valued less by investors than the subsidiary is/was.

Question 4

What is the investment strategy in this case according to the paper?

Answer 4

Short the stocks of the subsidiary and long the parent, to benefit from the slowly (sluggish) reacting market.
The returns of the parent (RTparent > RT subsidiary) by 30%-33% on average.

Question 5

What is a short interest?

Answer 5

the total amount of shares of stock that have been sold short relative to the total amount of shares outstanding. It is an indicator of market sentiment.

Question 6

what is a Synthetic short and how to achieve it?

Answer 6

use options to simulate the payoff of a short stock position
- Buy at-the-money puts and sell at-the-money calls.
- Borrow the present value of the strike price.
- In the paper the synthetic short price is constructed by selling a six-month at-the-money

Question 7

What are the conclusions of the paper?

Answer 7

 the negative stubs are evidence of a violation of the efficient market hypothesis prices
reflect fundamentals/law of one price); a mispricing
 investors buy the subsidiary to ‘ride the bubble’, or using the ‘greater fool theory’ (if I buy
it, there will always be a greater fool that will buy the stock from me)
 reasons for the violation of the ‘law of one price’ are limits to arbitrage; short-sale
constraints (availability and costs to short the stock)
 limits of arbitrage can cause market segmentation
 Systematic irrationality among a subset of investors can cause the prices to deviate from
fundamental value for a longer period of time; noise-trader risk