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Behavioral Finance

This analysis delves into the financial intricacies surrounding Bear Stearns (BSC) during its turbulent period from March to September 2007. With a market capitalization of $160 billion and a balance sheet showcasing $691 billion in assets and $669 billion in liabilities, Bear Stearns faced significant challenges amid the decline of structured debt and investment banking. We also explore potential outcomes following JPMorgan's acquisition offer, shareholder dynamics, and the behavior of bondholders and hedge funds. The discussion references the implications of Eugene Fama and Kenneth French's research on expected stock returns, emphasizing the factors driving market decisions.

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Behavioral Finance

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  1. Behavioral Finance Economics 437

  2. Bear Stearns (BSC) 160 105 80 52 30 4 1/2 May 2007 Sept 2007 Mar 1 Wed Today

  3. A Look at the Balance Sheet for Lehman Brothers (Market Cap $ 16 B) • Assets $ 691 Billion • Liabilities $ 669 Billion • Book Equity $ 22.4 Billion • Try Goldman Sachs (Market Cap $ 60 Billion) • Assets $ 1.2 Trillion • Liabilities $ 1.08 Trillion • Book Equity $ 37 Billion)

  4. The two big enchiladas • Structured debt • CDOs, SIVs, etc. • The repo market • Plus • The demise of structured debt and ibanking

  5. The JPM acquisition of BSC • $ 2 per share …. $ 230 million • If shareholders vote it down (in six weeks) • JPM has an option to buy their Park Ave headquarters for $ 1.1 billion (now estimated to be worth $ 1.4 billion) • JPM has an option to buy 20 % of the outstanding stock for $ 2 • First shareholder vote will be in June • If vote is “no”, can continue to re-vote for one year

  6. Deal announced 6PM Sunday night Trading Since Deal Announced $ 7 $ 5.50 Why? $ 3 $ 2 $ 2 Monday Tuesday Wednesday

  7. Why is stock above $ 2? • Anger of Bear Stearns employees and Lewis, the 8.5% shareholder. Buy to vote “no” • Enthusiasm of bondholders • Much of their debt was trading at 70 cents on the dollar • If deal goes through, they get 100 cents on the dollar • So they buy, to vote “yes” • Hedge funds: buy to threaten to vote “no” unless the deal is “sweetened”

  8. So, what will happen • What will not happen? • No new suitor will emerge • BSC will not go bankrupt • Outcome • $ 2 per share with 70 % probability • $ 5 - $ 7 per share with 30 % probability

  9. Eugene Fama and Kenneth French: “The Cross Section of Expected Stock Returns,” 1992 • Background • CAPM predicts that “β” explains stock returns • Evidence says “no relationship” • So, what does “explain” stock returns, if not “β” • Size seems to be a predictor in previous research • Lower size implies higher returns

  10. Results of F-F Empirical Work • BE/ME and ME are main predictors of returns • Not beta • Not P/E • Interpretation • Markets could be irrational: EMH is false • EMH is true • There are other “factors” that are “proxied” by BE/ME • Beta’s impact is obscured by • Mismeasurement of beta • Obscured by other variables

  11. End

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