Suppose that all investors have the disposition effect. A new stock has just been issued at a price of $50, so all investors in this stock purchased the stock today. A year from now the stock will be taken over, for a price of $60 or $40 depending on the news that comes out over the year. The stock will pay no dividends. Investors will sell the stock whenever the price goes up by more than 10%. a. Suppose good news comes out in 6 months (implying the takeover offer will be $60). What equilibrium price will the stock trade for after the news comes out, that is, the price that equates supply and demand? b. Assume that you are the only investor that does not suffer from the disposition effect and your trades are small enough to not affect prices. Without knowing what will actually transpire, what trading strategy would you instruct your broker to follow?

Suppose that all investors have the disposition effect. A new stock has just been issued at a price of $50, so all investors in this stock purchased the stock today. A year from now the stock will be taken over, for a price of $60 or $40 depending on the news that comes out over the year. The stock will pay no dividends. Investors will sell the stock whenever the price goes up by more than 10%. a. Suppose good news comes out in 6 months (implying the takeover offer will be $60). What equilibrium price will the stock trade for after the news comes out, that is, the price that equates supply and demand? b. Assume that you are the only investor that does not suffer from the disposition effect and your trades are small enough to not affect prices. Without knowing what will actually transpire, what trading strategy would you instruct your broker to follow?

Microeconomics: Principles & Policy

14th Edition

ISBN:9781337794992

Author:William J. Baumol, Alan S. Blinder, John L. Solow

Publisher:William J. Baumol, Alan S. Blinder, John L. Solow

Chapter9: The Financial Markets And The Economy: The Tail That Wags The Dog

Section: Chapter Questions

Problem 5TY

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