Abstract
We develop an asset-pricing model to quantify how a typical behavior of retail investors affects stock prices in equilibrium. Retail investors like distressed stocks. Hence, in a distress scenario, their increased demand, coupled with high short-selling costs, allows agents to exit at higher prices. Rational investors anticipate this and agree to overpay in normal times. This effect is economically large for popular high-risk stocks. The model parameters are estimated using detailed trading data on OGX, a failed Brazilian oil giant. We estimate an overpricing of 6% well before distress, and an average overpricing of US$ 1.7 billion over two years.
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