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Case Study

The Volkswagen short squeeze

12 pages

October 2012

Reference: IMD-1-0318

On 28 October 2008, the price of Volkswagen common shares exceeded €1,000. The case aims to explain this apparent market distortion using rational arguments such as the tentative takeover of Volkswagen by Porsche and the role of derivatives, particularly delta hedging. Although the events in the case did happen (the unusual stock price reaction), the storyline is purely fictional and illustrates the sequence of events in the day of an investment bank asked by a Porsche executive to underwrite call options on Volkswagen shares. Mark Johnson, managing director of a mid-sized NY-based investment bank, (and proud owner of a Porsche) receives a phone call from Anne, former classmate at Cal Tech and now a senior executive at Porsche, the German car manufacturer. She asks Mark whether his investment bank would be willing to underwrite some call options written on Volkswagen shares. Mark, intrigued by the request, asks his team of experts to look into the details. Why is Anne calling Mark? What is behind this unusual offer? Aren’t there banks in Germany? Several characters are introduced to give different perspectives on the rationale behind the option pricing exercise. The case presents a unique learning opportunity since it combines important teaching and academic objectives (option pricing, dynamic replication and delta hedging) with other topics such as fast cars like Porsche and the ramp-up in the price of Volkswagen stock. It also gives some insight into the practices of investment banks (or any other financial institution) and shows how they can impact outcomes.

Learning Objective

The case is based in 2008 and deals with the tentative takeover of Volkswagen by Porsche and the role of derivatives (and delta hedging) in contributing to the unusual price reaction of Volkswagen’s stock. It presents a unique learning opportunity since it combines important teaching and academic objectives (option pricing, dynamic replication and delta hedging) with other topics such as fast cars like Porsche and the ramp-up in the price of Volkswagen stock from €34 to more than €1,000 per share at one stage during the period that the case analyzes. The case has been designed to help participants understand that esoteric topics such as dynamic replication and delta hedging are indeed the bread and butter of modern investment banking rather than an academic abstraction. It gives some insight into the practices of investment banks (or any other financial institution) and shows how they can impact outcomes. The assignment questions in the teaching note may be rather basic, but the insights that are gained into option pricing and hedging are very deep.

Keywords

Option Pricing, Hedging, Delta Hedging, Risk Management, Car

Settings

Europe
Porsche, Volkswagen
2008

Type

Published Sources

Available Languages

English

Related material

Teaching note

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