The failure of IndyMac: A test market efficiency and behavioral challenge

Document Type

Article

Publication Date

2010

Abstract

This event study tested the effect of the IndyMac Bank failure announcement on the stock prices’ rate of return for a randomly selected sample of 30 banks; 15 savings and loan banks and 15 money center banks traded on either the NYSE or the NASDAQ. Using standard risk adjusted event study methodology with the market model, the study analyzed 6,541 recent observations on the thirty publicly traded firms and the corresponding S&P 500 market index. Results show the IndyMac bank failure announcement had a significant negative impact on the firm’s share price up to 30 days prior to announcement day 0. The risk adjusted return of the stock price is not significantly affected by this type of information on the announcement date. Likewise, the risk adjusted return of the stock price of the two samples of banks is significantly affected around the announcement date as defined by the event period. This finding supports the significance of the information around the event since the market’s reaction was observed. Finally, results show the reaction of risk adjusted return of the stock price of the sample of money center banks to the IndyMac bank failure announcement is not significantly different from the reaction of risk adjusted return of the stock price of the sample of savings and loan banks around the announcement date as defined by the event period. Overall, findings support efficient market theory at the semi-strong form level as documented by Fama (1970). Similar to many other event study findings in the finance literature (stock options, repurchase, dividend announcements etc.), apparently trading activity on the basis of this information surfaced prior to it being made public. Likewise, evidence of the behavioral challenge was observed by the significant overreaction of the risk adjusted rate of return of the sample of financial firms to the IndyMac bank failure news.

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