The overpricing of popular high-risk stocks
65 Pages Posted: 24 Mar 2021 Last revised: 13 Oct 2021
Date Written: October 13, 2021
We argue that the sheer rational expectation about some typical behaviors of retail investors can induce large and persistent overpricing in popular high-risk stocks. It is well-known that retail investors like distressed stocks. Hence, in a distress scenario, retail investors' increased demand, coupled with high short-selling costs, will allow agents to exit at higher prices, as if they had a put option. Anticipating this, rational investors agree to overpay in normal times. We develop a quantitative asset-pricing model and tightly calibrate it using detailed trading data on OGX, a failed Brazilian oil giant that was popular among retail investors. We estimate an overpricing of 6% well before distress hits, and an average overpricing of US$ 1.7 billion over almost two years.
Keywords: overpricing, misallocation, limits to arbitrage, behavioral biases, distressed firms, contrarian
JEL Classification: G12, G14, G40
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