HCBE Faculty Articles

Title

Trading Responses to Negative Signals

Document Type

Article

Date

6-2014

Publication Title

Theoretical Economics Letters

ISSN or ISBN

2162-2078

Volume

4

Issue

6

First Page

378

Last Page

385

Description

Mergers may be undertaken by giving shareholders of the target firm the right to exchange their stock for stock in the combined firm. Such stock mergers release the negative signal that the acquiring firm lacks cash. Informed traders seeking immediate gain may short sell acquirer stock or buy puts and sell calls. Liquidity traders, desiring longterm gain, may purchase stock or call options to benefit from lower stock prices, or sell stock or buy put options to maintain liquidity. This paper constructs a theoretical model in which option volume forms the bounds of the final stock price for informed traders while random stock purchase or sale volume establishes the final stock price for liquidity traders.

DOI

10.4236/tel.2014.46049

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