Market Efficiency and Limits to Arbitrage: Evidence from the Volkswagen Short Squeeze

with Franklin Allen, Marlene Haas, and Eric Nowak

Journal of Financial Economics, (2021) 142 (1): 166-194, [coverage by Harvard Law School Blog]


Abstract: On October 26, 2008, Porsche announced a largely unexpected domination plan for Volkswagen. The resulting short squeeze in Volkswagen's stock briefly made it the most valuable listed company in the world. We argue that this was a manipulation designed to save Porsche from insolvency and the German laws against this kind of abuse were not effectively enforced. Using hand-collected data we provide the first rigorous academic study of the Porsche-VW squeeze and show that it significantly impeded market efficiency. Preventing manipulation is important because without efficient securities markets, the EU's major project of the Capital Markets Union cannot be successful.

In Peer-Reviewed Journals

Levered and inverse VIX ETP option contract adjustments: No harm, no foul?

with Bob Whaley

solicited by Accounting & Finance, (2020) 60 (4): 3253-3277, [coverage by Bloomberg]


Abstract: The terms of exchange‐traded stock option contracts are usually adjusted when corporate actions take place. These adjustments are made to safeguard the value of the outstanding option contracts. Recently, a new type of corporate event has appeared − levered and inverse exchange‐traded product issuers are reducing leverage ratios with increased frequency. While such changes directly affect option values, no contract adjustments are made, resulting in windfall transfers of wealth from outstanding long to outstanding short option holders. In one instance alone, the transfer was more than $US 100 million. To remedy the problem, we offer a simple contract adjustment procedure.

Working Papers

The Value of Borrowing Diversity: Evidence from the Financial Crisis of 2007-2009 

      Best Paper Award, Swiss Society for Financial Market Research


Abstract: Does borrowing diversity (i.e., borrowing via a larger number of debt types) affect how firms respond to an exogenous credit supply shock? To answer this question I use the recent 2007-2009 credit crisis as a negative exogenous credit supply shock to U.S. non-financial companies. Applying a difference-in-differences methodology, I find that during the crisis companies that ex ante borrowed from many debt types had significantly higher capital expenditures than otherwise similar companies that borrowed from fewer debt types. The former group also had higher market valuations, a lower cost of debt, a lower reduction in debt issuance, higher leverage ratios, and a lower need to use internal cash during the crisis. This evidence is robust to applying an instrumental variable estimation, which takes into account the endogenous nature of the diversity measure. Finally, further tests suggest that borrowing diversity could represent a valid measure for financial constraints.


Presentations: Georgetown University, University of Miami, Federal Reserve Board of GovernorsFederal Reserve Bank of Richmond, FMA USA, SFI Corporate Finance Workshop, Erasmus University, BI Norwegian Business School, ESADE, Cornerstone Research, EFA Doctoral Tutorial, SGF Conference, Australasian Finance and Banking Conference, Northwestern Causal Inference Workshop, EFMA, Austrian Working Group on Banking, University of Vienna, VGSF Annual Students Conference

Accounting Covenants in Credit Lines: Protecting Banks Against Aggregate Liquidity Shocks

with Maria Chaderina and Christian Laux


Abstract: We discuss a novel role for covenants and accounting-performance measures in credit lines. During aggregate liquidity shortages, banks need to ration liquidity. Credit line covenants allow a bank to revoke the credit line if a firm's accounting-performance measure falls below some threshold. Revoking credit lines protects banks against severe aggregate liquidity shocks. Idiosyncratic and transitory shocks in the accounting-performance measure have two benefits. First, they introduce randomness in covenant violations that eliminates concerns of favouritism when banks ration liquidity. Second, when transitory shocks are correlated with the level of aggregate liquidity shock, the likelihood of covenant violations after severe aggregate shocks is higher than in normal times, improving the allocation of liquidity. Implicit liquidity insurance can complement covenants, inducing banks to revoke credit lines of covenant violators only after severe aggregate shocks, not in normal times. Consistent with this revocation pattern, we find a positive association between covenant violations and credit line revocations in the crisis of 2007-2008, controlling for firm fundamentals, but not outside the crisis.


Presentations: Columbia Business School*, Cass Business School*, NYU Stern*, Temple University*, University of Washington*, VGSF, The Accounting Research
Workshop in Zurich*, European Accounting Association*, The Accounting Group Meeting of the German Economic Association*, EWFS*, FDIC/JFSR conference*, University of Melbourne*

Valuation and long-term growth expectations

with Josef Zechner and Jeff Zwiebel


Abstract: A standard DCF corporate valuation usually includes a terminal value based on a long-term growth rate to reflect value from beyond the typical forecasting horizon of three to seven years. Despite often having a dominant effect on overall firm value, both the academic literature and practitioner conventions provide very little guidance on how this long-term growth rate should be determined. This paper addresses this gap: we undertake an exploratory analysis of how firms’ long-term growth is related to various firm and industry characteristics. We apply an extensive selection of potential predictors based on firm, industry, and market characteristics, in order to explain the variation in firms’ long-term growth rates. As such, we provide a predicted long-term growth rate for all firms, which can then be used as an input into a DCF valuation. We find that market prices do not seem to capture the full information that we find in long-term growth predictions. Thus, a trading strategy that goes long the decile with the highest long-term growth expectations and short the bottom decile yields positive and statistically significant abnormal returns in the range from ten to thirteen percent per year.


Presentations: Vanderbilt, VGSF, Spängler IQAM, Silicon Prairie Finance Conference, St. Gallen, NFA, FMA USA, University of Maryland, Johns Hopkins University

Squeezing Shorts Through Social Media Platforms

with Franklin AllenMarlene HaasEric Nowak, and Matteo Pirovano

Abstract: At the end of January 2021, a group of stocks listed on US stock exchanges experienced sudden surges in their stock prices, which - coupled with high short interest – led to short squeeze episodes. We argue that these short squeezes were the result of coordinated trading by retail investors, who discussed their trading strategies on social media platforms. Contrary to popular beliefs, bot activity on social media did not play a role. However, option markets played a central role in these events. Using hand-collected data we provide the first rigorous study of these short-squeezes and show that they significantly impeded market quality not only of the stocks at issue but also of their competitors. Thus, we contribute to the debate about the benefits and the risks associated with increased retail investor participation in capital markets. The evidence also calls for tighter monitoring of social media platforms and a better understanding of the inter-linkages between these platforms, derivatives markets and equity markets.

Presentations: FMA USA, German Finance Association Annual Meeting, Paris December Finance Meeting 

Creditor Control Rights and the Pricing of Private Loans

with Marc Arnold and Nicola Kollmann

Abstract: This paper investigates the influence of creditor control rights on the pricing of corporate loans. We construct a novel dataset, which combines hand-collected covenant violations data with information about individual borrower, creditor, and loan characteristics. Importantly, our data identifies creditors that receive direct control rights after a covenant violation and creditors that do not receive those rights after a covenant violation. By comparing the loan terms of these two creditor types, we isolate the impact of creditor control rights on loan pricing from the impact of other factors related to covenant violations. We find that creditors exploit their control rights to overprice new loans. In addition, we uncover novel cross-sectional and time-series loan pricing patterns that can be explained by creditor control rights.

Presentations: St. Gallen*