Abstract
After experiencing significant stock price run-ups, a firm becomes overweight in its shareholders’ portfolios, subjecting them to excessive firm-specific risk and creating portfolio rebalancing needs. If the firm cannot attract sufficient buying interests, selling pressure from rebalancing leads to undervaluation. The firm can resolve the undervaluation problem by splitting its shares to attract new investors to better facilitate shareholders’ portfolio rebalancing. Since undervaluation attracts informed trading and makes listed options more appealing, we analyze stock price behavior and relative trading of options over stock surrounding stock splits and find compelling evidence consistent with our portfolio-rebalancing hypothesis of stock splits.
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