Noise Demand, Limits of Arbitrage, and Stock Price Bubbles : Evidence from Mergers and Acquisitions

We hypothesize there is an increased noise demand for stocks of acquirers in response to acquisition announcements and that the demand is greater for acquirers with higher uncertainty in their equity valuation. Using idiosyncratic volatility to measure uncertainty, we find support for limits of arbitrage theories. Announcement period abnormal returns are higher for more uncertain acquirers, but the return pattern reverses over the longer term, resembling a transitory price bubble. The bubble is greater when deal and firm characteristics exacerbate the limits of arbitrage and it weakens over time. Also, transactions by more uncertain acquirers are more likely to fail