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i may be missing the forest for teh trees here but in what scenario would a small business stock not go up in the situation described by DS?? aka, a small company has a valueable idea that is huge to the company and it is either defending or prosecuting that idea in court. eventually the verdict comes out in favor of the small company... what would cause the price of that company's stock to drop as a direct result of the favorable ruling?? [img]/images/graemlins/confused.gif[/img]

Barron

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If the market had expected, and priced in, an even more favourable ruling then was received.

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QFT, or even an 'equivalent' ruling. If the equity falls to a 'market return' Beta, the current holders may be seekers of higher Beta/[alpha as well] stocks and not be interested in holding a stock that will only return = the market. Etc.

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i think you may have drifted over my head here.

take me through this proces real quick.

so a biotech stock price is at $50/share. it has been trading on the NYSE for 10 years. this company has never been involved in litigation before. it is estimated that the beta for this stock is 1.5 based on historical monthly returns vs. the mkt. 1yr ago the company got involved in a lawsuit relating to its blockbuster product accounting for 70% of its sales. lets say there are 5 states of the ruling that comes out tomorrow.

1) more highly favorable
2) more favorable
3) identical to what was priced in
4) more unfavorable
5) more highly unfavorable

how would the beta change from 1.5 in each of those cases, and why?

before answering, could you explain how there is even an answer to that?? the way i understand it (and i could easily be wrong here), the beta is a historical measure that is supposed to look at the returns of this security vs. the mkt and the extent to which it is riskier, the security's beta increases. so an event occurs and the theoretical beta changes, right?

but the actual beta (estimated by regressing the excress returns of that stock vs. the excess mkt returns) can't change immediately. so now, people who use the CAPM approach to stock valuation utilize some new beta to arrive at the discount rate of the firm? and everybody just guesses at it?

so these facts lead me to believe that the change in beta is simply theoretical and results from logical analysis. in turn, here's how i'd guess at the answers i asked you for:

1) beta should either increase or decrease. Increase: people who were awaiting a ruling to invest will now buy, increasing price & volatility. Decrease: earnings are no longer as questionable and the stock could be less risky now than it was prior to this ruling.

2) beta should increase or decrease, though by not as much as 1). i can see logical reasons for both here as with above.

3) beta should remain at ~1.5. stock's returns should be no more or less variable vs. the mkt.

4) same as 3) ... i tend to go with more risky here and maybe less risky for 3) as the stock is now expected to do worse/better than priced in respectively. id further have to guess that a more unfavorable ruling would change the beta more than a proportionally more favorable ruling.

5) beta should increase. it should change by as much or more than 1), probably more.

so i dont see a case where the stock would become less risky & thus reduce its beta vs. the mkt (unless of course the ones that are more favorable reduce the beta because now the stock has stronger earnings prospects... but that should still be more volatile in price of the stock terms than what has been seen in the past). so in the case of the identically as favorable ruling, doesn't the beta of the stock remain the same and thus those who were holding it for the 1.5beta should still hold it for that same beta? how would the beta be reduced to 1 (mkt perform)?

i guess in this case it probably won't...but if the beta is like 1.05 or something it is more reasonable for it to drop to 1.0. hwoever, i don't see how a .05 higher beta would attract high beta seekers in the first place nor how a drop of .05 would scare off investors who wanted to hold the stock prior?

anyways, i've asked a ton ... how is the logic here so far?? also, if you can, let me know where i've gone astray and why

Thanks in advance,
Barron