The overpricing of popular high-risk stocks

Abstract

Individuals like distressed stocks. Hence, in a distress scenario, their increased demand, coupled with short-selling costs, allows agents to exit at higher prices. Anticipating this, rational investors agree to overpay in normal times. This paper develops a model that can be used to quantify this effect. We illustrate how to estimate the model by studying the case of OGX, a failed Brazilian oil giant. We estimate an overpricing of 6% in equilibrium, meaning a daily average capital misallocation of US$ 1.7 billion over two years.

Keywords: overpricing, misallocation, limits to arbitrage, behavioral biases, distressed firms, speculative bubbles

JEL Classification: G12, G14, G40