In the current worldwide financial meltdown, almost every stock market is crashing. However Volkswagen defied gravity, went up 500% in a week become the world’s latest company in market capital. Last week, the stock price of Volkswagen shot up to 1000 euros from 200 euros. This rare stock phenomena seems common sense, what is so great about a struggling German car manufacturer. Then I read this week’s Economists and get the picture behind the scene. The jump in stock price is due to short selling hedge fund manager get caught in a short squeeze. They have to buy the shares to cover their short selling at whatever market price and suddenly push up the demand of Volkswagen’s shares.

Porsche wanted to take over Volkswagen and slowly and secretly accumulating the shares. The hedge funds managers are betting against Porsche and short selling the shares. Last weekly suddenly Porsche reveal that it owns almost 3/4 of Volkswagen’s shares which is pretty much all the liquidity on the market. The rest of Volkswagen shares are owned by the government and institutions. The fund managers borrowed shares to short and they hope to buy back the shares at lower price to repay the borrowed shares. When the liquidity dries up, the supply is low while the demand is high, the price goes up. When the price goes up the fund manager has to and buy shares to cover the short position and push up the price even higher. It becomes a infinite squeeze that the hedge fund lost billions of dollars. It is a classic example of how the hedge funds punished by the market.