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Behavioral Finance

Behavioral Finance. Economics 437. Bear Stearns (BSC). 160. 105. 80. 52. 30. 4 1/2. May 2007. Sept 2007. Mar 1 Wed Today. A Look at the Balance Sheet for Lehman Brothers (Market Cap $ 16 B). Assets $ 691 Billion Liabilities $ 669 Billion Book Equity $ 22.4 Billion

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Behavioral Finance

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  1. Behavioral Finance Economics 437

  2. Bear Stearns (BSC) 160 105 80 52 30 4 1/2 May 2007 Sept 2007 Mar 1 Wed Today

  3. A Look at the Balance Sheet for Lehman Brothers (Market Cap $ 16 B) • Assets $ 691 Billion • Liabilities $ 669 Billion • Book Equity $ 22.4 Billion • Try Goldman Sachs (Market Cap $ 60 Billion) • Assets $ 1.2 Trillion • Liabilities $ 1.08 Trillion • Book Equity $ 37 Billion)

  4. The two big enchiladas • Structured debt • CDOs, SIVs, etc. • The repo market • Plus • The demise of structured debt and ibanking

  5. The JPM acquisition of BSC • $ 2 per share …. $ 230 million • If shareholders vote it down (in six weeks) • JPM has an option to buy their Park Ave headquarters for $ 1.1 billion (now estimated to be worth $ 1.4 billion) • JPM has an option to buy 20 % of the outstanding stock for $ 2 • First shareholder vote will be in June • If vote is “no”, can continue to re-vote for one year

  6. Deal announced 6PM Sunday night Trading Since Deal Announced $ 7 $ 5.50 Why? $ 3 $ 2 $ 2 Monday Tuesday Wednesday

  7. Why is stock above $ 2? • Anger of Bear Stearns employees and Lewis, the 8.5% shareholder. Buy to vote “no” • Enthusiasm of bondholders • Much of their debt was trading at 70 cents on the dollar • If deal goes through, they get 100 cents on the dollar • So they buy, to vote “yes” • Hedge funds: buy to threaten to vote “no” unless the deal is “sweetened”

  8. So, what will happen • What will not happen? • No new suitor will emerge • BSC will not go bankrupt • Outcome • $ 2 per share with 70 % probability • $ 5 - $ 7 per share with 30 % probability

  9. Eugene Fama and Kenneth French: “The Cross Section of Expected Stock Returns,” 1992 • Background • CAPM predicts that “β” explains stock returns • Evidence says “no relationship” • So, what does “explain” stock returns, if not “β” • Size seems to be a predictor in previous research • Lower size implies higher returns

  10. Results of F-F Empirical Work • BE/ME and ME are main predictors of returns • Not beta • Not P/E • Interpretation • Markets could be irrational: EMH is false • EMH is true • There are other “factors” that are “proxied” by BE/ME • Beta’s impact is obscured by • Mismeasurement of beta • Obscured by other variables

  11. End

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