Chapter 4
CAN THE MARKET ADD AND SUBTRACT?
MISPRICING IN TECH STOCK CARVE-OUTS
Owen A. Lamont and Richard H. Thaler
1.IntroductionThere are two important implications of the efficient market hypothesis.
The first is that it is not easy to earn excess returns. The second is that
prices are “correct” in the sense that prices reflect fundamental value. This
latter implication is, in many ways, more important than the first. Do asset
markets offer rational signals to the economy about where to invest real re-
sources? If some firms have stock prices that are far from intrinsic value, then
those firms will attract too much or too little capital. While important, this
aspect of the efficient market hypothesis is difficult to test because intrinsic
values are unobservable. That is why tests of relative valuation, for exam-
ple, using closed-end funds, are important. The fact that closed-end funds
often trade at substantial discounts or premia makes one wonder whether
other assets may also be mispriced.
The most basic test of relative valuation is the law of one price: the same
asset cannot trade simultaneously at different prices. The law of one price is
usually thought to hold nearly exactly in financial markets, where transac-
tions costs are small and competition is fierce. Indeed, the law of one price
is in many ways the central precept in financial economics. Our goal in this
chapter is to investigate violations of the law of one price, cases in which
prices are almost certainly wrong in the sense that they are far from the
frictionless price. Although the number of cases we examine is small, the vi-
olations of the law of one price are large.
We thank John Cochrane, Douglas Diamond, Merle Erickson, Lou Harrison, J. B. Heaton, Ravi
Jagannathan, Arvind Krishnamurthy, Mark Mitchell, Todd Pulvino, Tuomo Vuolteenaho, an
anonymous referee for the Journal of Political Economy, and seminar participants at the Ameri-
can Finance Association, Harvard Business School, the National Bureau of Economic Research
Asset Pricing meeting, and the University of Chicago finance lunch for helpful comments. We
thank Joe Cornell and Mark Minichiello of Spin-off Advisors for data and helpful discussions.
We thank Frank Fang Yu for excellent research assistance. Lamont gratefully acknowledges sup-
port from the Alfred P. Sloan Foundation, the Center for Research in Security Prices at the Uni-
versity of Chicago Graduate School of Business, the National Science Foundation, the Investment
Analyst Society of Chicago, and the Association for Investment Management and Research.