TAILIEUCHUNG - Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outsOwen A. Lamont and Richard H.

A preliminary investigation of the raw data reveals that in the 1998–2002 period, a few country portfolios (and the world portfolio) exhibit very high volatility. In particular, the TMT industries (information technology, media, and telecommunication) witnessed a tremendous increase in volatility during that period, as Brooks and Del Negro (2004) document. This increase in volatil- ity is also noticeable for the style portfolios, especially for the small firms. In the last few years of the sample, volatility returns to more normal levels, similar to the volatility levels witnessed in the early part of the sample | Can the Market Add and Subtract Mispricing in Tech Stock Carve-outs Owen A. Lamont and Richard H. Thaler University of Chicago and National Bureau of Economic Research Recent equity carve-outs in . technology stocks appear to violate a basic premise of financial theory identical assets have identical prices. In our 1998-2000 sample holders of a share of company A are expected to receive x shares of company B but the price of A is less than x times the price of B. A prominent example involves 3Com and Palm. Arbitrage does not eliminate this blatant mispricing due to short-sale constraints so that B is overpriced but expensive or impossible to sell short. Evidence from options prices shows thatshort-ing costs are extremely high eliminating exploitable arbitrage opportunities. I. Introduction There are two important implications of the efficient market hypothesis. The first is that it is not easy to earn excess returns. The second is that prices are correct in the sense that prices reflect fundamental value. This latter implication is in many ways more important than the first. Do asset markets offer rational signals to the economy about where to We thank John Cochrane Douglas Diamond Merle Erickson Lou Harrison J. B. Heaton Ravi Jagannathan Arvind Krishnamurthy Mark Mitchell Todd Pulvino Tuomo Vuol-teenaho an anonymous referee and seminar participants at the American Finance Association Harvard Business School the National Bureau of Economic Research Asset Pricing meeting and the University of Chicago finance lunch for helpful comments. We thank Joe Cornell and Mark Minichiello of Spin-off Advisors for data and helpful discussions. We thank Frank Fang Yu for excellent research assistance. Lamont gratefully acknowledges support from the Alfred P. Sloan Foundation the Center for Research in Security Prices at the University of Chicago Graduate School of Business the National Science Foundation the Investment Analyst Society of Chicago and the Association for .

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