Market Efficiency and Limits to Arbitrage: Evidence from the Volkswagen Short Squeeze

On October 26, 2008, Porsche announced its domination plan for Volkswagen. This announcement caused a short squeeze that briefly made Volkswagen the most valuable listed company in the world. Using this event and Germany's regulatory framework as a unique experimental setting, we argue that effective disclosure regulation and enforcement of securities laws are important in modern financial markets. We provide the first forensic academic study of the Porsche-VW squeeze and show that it significantly impeded price discovery and market efficiency. These limits to arbitrage in the form of short sale risks imply significant costs to the arbitrageurs involved.