When‐issued Shares, Small Trades, and the Variance of Returns Around Stock Splits

Abstract

The increases in volatility after stock splits have long puzzled researchers. The usual suspects of discreteness and bid-ask spread do not provide a complete explanation. We provide new clues to solve this mystery by examining the trading of when-issued shares that are available before the split. When-issued trading permits noise traders to compete with a more homogenous set of traders, decreasing the volatility of the stock before the split. Following the split, these noise traders reunite in one market and volatility increases. Thus, the higher volatility after the ex date of a stock split is a function of the introduction of when-issued trading, the new lower price level after the split date, and the increased activity of small-volume traders around a stock split. 2004 The Southern Finance Association and the Southwestern Finance Association.

The UK equity market around the ex-split date

“…On the empirical front, Lamoureux and Poon (1987), Schultz (2000) and Angel et al (2004) find an increase in institutional ownership following a split, while Ikenberry et al (1996) and Dennis and Strickland (2003) refute these findings. Examining the equity performance of firms executing stock splits, Fama et al (1969) and Byun and Rozeff (2003) found insignificant abnormal returns, which contradicts the results of Desai and Jain (1997) and Wu and Chan (1997).…”

The impact of stock split handling rules on returns: Evidence from Canada

“…Brooks and Chiou (1995) controlled for a variety of factors such as time of the transaction, and reported a premium of 0.75%. As further support of the inconvenience hypothesis, Angel, Brooks, and Mathew (2004) found that volume in the when-issued shares increases by three-fold following the record date of the stock split. Nayar and Rozeff (2001) argued and found evidence that the buyers' preference for when-issued shares versus unsplit shares near the record date leads to negative returns around that date.…”

The Dutch Grey Market

“…When-issued trading may also alleviate the inconveniences of trading in unsplit shares past the record date (Nayar and Rozeff 2001) or of receiving odd lot shares in the case of non-integer splits (Brooks and Chiou 1995). Angel et al (2004) point out that when-issued shares may attract small-volume traders; as such, they may increase liquidity in the market already before the effective split date.…”