The Lehman Brother's Bankruptcy: a Test of Market Efficiency

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Allied Academies International Conference

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THE LEHMAN BROTHER’S BANKRUPTCY: A TEST OF MARKET EFFICIENCY Christine Pichardo, Longwood University Frank Bacon, Longwood University ABSTRACT This study tests the market efficiency theory by examining the effect of the Lehman Brothers bankruptcy on several brokerage firms, as well as the overall market. It would suggest that these brokerage firms would occur negative stock prices following the announcement of the Lehman Bankruptcy. For this study, I analyzed 15 firms’ stock price’s risk adjusted rate of return before and after September 15, 2008, some with larger assets in Lehman than others. Results show stock prices dropping approximately 24 days prior to the announcement and continuing to drop for several weeks. This supports the semi-strong market theory; which suggest that the market anticipated the collapse of Lehman. INTRODUCTION When Lehman Brothers collapsed, they had about $60 billion in toxic bad debts, and had assets of $639 billion against debts of $613 billion; making it the largest investment bank to collapse since the 1990’s. With a bankruptcy of this capacity, you would expect the stock market to take some sort of hit. This study examines the market’s reaction to this event by analyzing the risk adjusted return of selected brokerage firms’ stock prices around the event date of September 15, 2008. LITERATURE REVIEW The concern for Lehman Brothers started as early as March, with the collapse of Bear Sterns. The recent collapse of large investment banks are the result of the sub prime mortgage crisis, which actually started about a year ago. That’s when the first signs that the soaring U.S. housing market was weakening. Interest rates began to increase, the economy weakened, which turned indebted homeowners into financial turmoil sparking foreclosures and rapid drops in house prices. Lehman Brothers were considered one of Wall Street’s biggest dealers in fixed-interest trading and were heavily invested in securities linked to the sub-prime mortgage market. They lost $14 billion in the past 18 months after being forced to take huge write downs on the value of those investments; which ultimately lead them to file for bankruptcy. When Lehman collapsed, it sent a rippling affect across the globe, exposing how interconnected international markets have become. One of the largest companies affected were AIG, who backed a majority of credit default swaps by Lehman Brothers. So, when Lehman collapsed, AIG and many other banks, firms and individuals felt the pain. Proceedings of the Academy of Accounting and Financial Studies, Volume 14, Number 1 New Orleans, 2009

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Allied Academies International Conference

September 15, 2008 has been proclaimed Wall Street’s worst day in seven years. The Dow Jones Industrial average lost more than 500 points, more than 4%, which is the steepest fall since the day after the September 11th attacks. DATA AND METHODOLOGY This study includes 15 investment firms, about 9 with a significant stake in Lehman, and 6 others. The purpose of this study was to see how fast and how much of an impact the bankruptcy of one of the largest investment firms affected the stock prices of those 15 firms. I analyzed the 15 firm’s prices, and the corresponding Standard & Poor’s 500 Index (S&P 500) from 180 days before the event date of September 15, 2008 and 30 days after. To test the affect of the bankruptcy on the 15 firms stock prices, and to test the semi-strong market efficiency theory; I used the following hypothesis. H10: The risk adjusted return of the stock price of the sample of investment firms is not significantly affected by this type of information on the event date. H11: The risk adjusted return of the stock price of the sample of investment firms is significantly negatively affected by this type of information on the event date. H20: The risk adjusted return of the stock price of the sample of the investment firms is not...
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