BANKRUPTCY PLAYS

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"Gambling on the market: who buys the stock of bankrupt firms?"

"ABSTRACT
This paper asks whether the stocks of bankrupt firms are correctly priced, and explores who
trades the stocks of these firms, and why. Our sample consists of firms that enter into Chapter 11
and remain listed on the NYSE, AMEX, and NASDAQ post-filing. We show that these stocks
are heavily traded by retail investors who are also their main stockholders. We further document
that these stocks have unique lottery-like characteristics, and that retail investors trade in such
stocks as if they were gambling on the market. Buying and holding such securities leads, on
average, to a negative realized abnormal return of at least -28% over the 12 months after the
Chapter 11 filing. However, we find that arbitrageurs are not able to exploit this market-pricing
anomaly due to implementation costs, and high attendant risks. We thus conclude that a
combination of gambling-motivated trading by retail investors, and limits to arbitrage, seems to
lead to the anomalous results we document. Our paper thus provides an answer to the Fama-
French recent question on their blog – “Bankrupt Firms: Who’s Buying?”.

https://www.cass.city.ac.uk/__data/assets/pdf_file/0003/79464/Coelho-4a.pdf