The Game Stop case

GameStop stock?

Robinhood's specific characteristic that made it the main means through which the order flow

for buying GameStop stock was channeled is its commission-free trading model. This model

allowed users to trade stocks without paying any commissions, making it popular among

retail investors. The ease of use of the Robinhood app, combined with its gamified interface

and accessibility through mobile devices, attracted a large number of users who were

interested in trading stocks, including volatile stocks like GameStop.

7.4 How is the order flow originated by retail investors executed by

Robinhood broker (hint: have a look at the app terms and conditions). When

buying stocks on Robinhood are you executing a market buy (hint: recall

differences between a market order and limit order)? If not, for what reasons

the broker does not allow it?

Robinhood executes the order flow originated by retail investors through a process known as

payment for order flow (PFOF). This means that Robinhood routes its customers' orders to

market makers in exchange for receiving compensation. Market makers are firms that buy and

sell securities on exchanges at publicly quoted prices. When buying stocks on Robinhood,

users are generally executing a market buy order by default. A market order is an order to buy

or sell a stock at the current market price, ensuring the order gets filled but not specifying the

price. On the other hand, a limit order is an order to buy or sell a stock at a specific price or

better. Robinhood does not allow users to place limit orders on certain highly volatile stocks,

including GameStop, during times of extreme market volatility. This restriction is put in place

to manage risk and protect both the investors and the broker from sudden price fluctuations

that can occur with highly volatile stocks. By limiting the types of orders that can be placed on

these stocks, Robinhood aims to ensure a more orderly market and reduce the chances of

large losses for investors.

7.5 Could the trading on GameStop be considered a “pump and dump”

situation? Or other situation of market manipulation?

The trading on GameStop could be considered a situation that exhibits characteristics of a

"pump and dump" scheme or market manipulation, although the situation is complex and

may involve various factors beyond a simple pump and dump. A "pump and dump" scheme

typically involves inflating the price of a stock through misleading or false statements in order

to sell it at a higher price ("pump") and then quickly sell off the stock before the price falls

("dump"). In the case of GameStop, there was a significant surge in the stock price driven by a

coordinated effort by retail investors on platforms like Reddit's WallStreetBets to drive up the

price by buying and holding the stock. While the situation with GameStop does share

similarities with a pump and dump scenario, it also involves elements of a short squeeze,

where investors betting against the stock (short sellers) were forced to buy the stock to cover

their positions as the price rose dramatically. Market manipulation can take many forms, and

it is up to regulatory authorities to investigate and determine if any laws were broken. It's

important to note that the GameStop situation has raised questions about market dynamics,

the role of retail investors, the power of social media in influencing stock prices, and the

responsibilities of brokers and market regulators in ensuring fair and orderly markets.

7.6 Chart Gamestop returns and volatility over the period 2020-2023

7.7 Calculate "normal return" on GameStop stock according to the single

index model and then calculate the abnormal return on Jan 27th 2021 (AR =

Return27Jan - Rindex model)

After calculating beta (= 1,186445942) and alfa (=0,001320163) we calculated that the normal

return is -0.029411, multiplying the return on S&P at the date Jan 27 2021 to beta and adding

th

alfa.

The abnormal return is given by the return of Gamestop minus the normal return, so 88.313%.

7.8 Would you consider GameStop a profitable firm? Support your answer

using selected financial ratios and relative multiples

GameStop is not a profitable firm based on the 2023 financial data and the calculated ratios.

The company is operating at a loss, with negative profitability ratios. The high EV/EBITDA ratio

suggests that the market may have speculative expectations or other factors influencing its

valuation, but from a pure financial perspective, profitability is lacking.

7.9 The rise of GameStop’s stock prices can change the financial position of

the firm? Did it make it easier or more difficult for the firm to survive in the

longer term?

The rise in GameStop’s stock prices in 2021 definitely changed the firm’s financial position:

the major videogame retailer decided to issue new shares and to raise much capital, which

improved its liquidity and reduced its debt. This big inflow of funds was ideal for the company

to transform its business model towards e-commerce and digital technologies, in addition to

attracting many experts in these areas.

The firm’s new dimension increased the attention of the media and consequently investor

confidence, which resulted in boosting its long-term potential. Obviously, there were also

some new challenges that had to be faced, such as managing investor’s increased

expectations and the risk of diluting existing shares, because of the big increase in their

number but without pre-emption rights for old shareholders. In conclusion, the stock price

rise made it easier for Gamestop to potentially survive in the longer term, but also brought

new risks to face.

7.10 What kind of behavioral biases - if any- do the different agents

(investors, hedge fund managers, regulators) have shown during the "saga"?

The GameStop saga illustrated how various behavioral biases can influence different market

participants. Retail investors exhibited biases such as herding, FOMO, confirmation bias, and

overconfidence, while hedge fund managers were affected by short-squeeze phenomena,

loss aversion, and anchoring.