Ex-Dividend Stock Price Behavior and Arbitrage Opportunities

Abstract

This paper investigates the relation between ex-dividend stock price behavior and arbitrage oppor tunities. In a continuous trading, frictionless economy, the authors demonstrate that it is possible for the ex-dividend stock price drop to differ from the dividend, and still short-term traders cannot gene rate arbitrage profits. The argument is independent of transactions c osts. The relevance of this insight to estimating the marginal tax br acket based on ex-dividend stock price drops is explored. Furthermore , this insight is also applied to the area of option pricing in which the special class of escrowed dividend stock price processes is stud ied. The authors show that most elements from this class of stock pri ce processes generate invalid option-pricing formulas. Copyright 1988 by the University of Chicago.