Can the Market Divide and Multiply? A Case of 807 Percent Mispricing

Abstract

This paper documents a strong violation of the law of one price surrounding a large rights issue. If prices are right, the relation between the prices of shares and rights follows the outcome of a simple calculation. In the case of Royal Imtech N.V. in 2014, prices deviated sharply and persistently from the theoretical prediction. Throughout the term of the rights, investors were buying shares at prices that were many times what they should have been given the price of the rights. Short-selling constraints in the form of high recall risk and lacking stock lending supply are the most likely explanation for the failure of arbitrage as a safeguard of market efficiency. Still, it remains remarkable that investors were buying large volumes of shares at highly inflated prices in the presence of a cheap, perfect substitute.

Keywords: law of one price, market efficiency, mispricing, limits to arbitrage, short-sale constraints

JEL Classification: G12, G14, G40