Corporate Financial Strategy and Stock Price Behavior in a Noise Trader Model with Limited Arbitrage


In this paper, we attempt to explain the stock price decreases following equity offerings and stock price increases following stock repurchases, both of which have been identified by empirical studies. By examining corporate financial strategies in the limited arbitrage-noise trader model presented by Shleifer and Vishny (1990, 1997), we can explain those anomalies. When a market with an optimistic noise overvalues stock prices, a firm can earn capital gains by selling new shares at the overvalued price. On the other hand, when the pessimistic market undervalues stock prices, a firm can enjoy capital gains by buying its shares at the bargain price. In the event that a noise disappears, a firm issuing shares experiences the continual stock price decrease, and a firm repurchasing its shares experiences the continual stock price increase.

Key Words:
noise trader model, equity offering, stock repurchase, stock price anomaly

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