Building investment strategies on internet takeover rumours

Halldór Jónsson & Christian Elbek Pedersen

Student thesis: Master thesis

Abstract

This thesis examines the market reaction to takeover rumour postings on the RagingBull Internet Message Board. The study builds on prior literature on rumours and conducts an event study to identify the economic impact of takeover rumours on stock prices. In addition we apply a takeover-likelihood model introduced by Palepu (1986) in order to test if we can successfully identify companies that are unlikely to be target of a takeover. This model is introduced as we expected that there will be a great overreaction to takeover rumours, particularly the ones that turn out to be false. The findings from the event study and takeoverlikelihood model is then tested to see if it can be used to build a profitable investment strategy. The results of the event study confirms the main hypothesis that the financial market overreacts to takeover rumours. Furthermore the study also shows that Small- and Mid Cap firms experience significantly higher reaction to rumours than Large Cap in the event window. Results also show that rumours with origin in another reliable source and initial rumours depicts high return in the event window. However, the group of rumours that causes the highest overreaction to stock prices is, as correctly assumed, false rumours. The final takeover-likelihood model includes three variables of the initial 15 examined. This is respectively; Sales, Other reliable source and repeated rumour. Despite showing some power of predictability, the model was unable to improve the investment strategy of short selling all rumours. As investors are not able to distinguish between true and false rumours at the day of publication, the best feasible investment strategy turned out to be the one short selling initial rumours for 90 days. This strategy yields annual return of 17,83% compared to 10,28% for the Equally Weighted Market Index. We conclude that investors overreact to takeover rumours posted on the Ragingbull and that the informed investors can gain substantially on forming a strategy built of this information though not without taking on excessive risk.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2011
Number of pages109