FRANKFURT (Reuters) - Volkswagen VOWG.DE briefly became the world's biggest company by market value on Tuesday, as short sellers caught betting on a price drop with borrowed stock scrambled to find shares after a buying spree by Porsche PSHG_p.DE.

A share trader points on the curve showing the course development of the shares of German car manufacturer Volkswagen AG on a trading terminal at the German stock exchange in Frankfurt, October 28, 2008. REUTERS/Kai Pfaffenbach

Short sellers desperate to close their positions paid as much as 1,005 euros a share during the session following Sunday’s news that there was less than 6 percent of VW voting stock still floating in the market.

At that price Volkswagen's voting stock was worth 296 billion euros ($370 billion), or more than the $343 billion market capitalization of Exxon Mobil XOM.N.

VW shares later closed trading on Tuesday up 82 percent at 945 euros.

The share price has rocketed since Porsche revealed in a surprise announcement on Sunday that it had effectively gained control of 74 percent of Volkswagen’s voting shares.

In March, when Porsche was still sitting on a long-held 31 percent direct stake, it said it was not seeking to increase its holding to 75 percent, bearing in mind that the state of Lower Saxony holds a 20 percent stake in VW.

“The speculation of going to 75 percent overlooks the realities of the shareholder structure of VW, Porsche said at the time.

“In view of the fact that Lower Saxony as second largest shareholder owns 20 percent of VW, the probability of acquiring the necessary shares in freefloat is extremely low.”

Meanwhile on Tuesday a spokesman for German market regulator BaFin said it was looking into the VW share price movement for any sign of insider trading or market manipulation.

Porsche denied it was manipulating the market and said that the market had mixed up cause with effect.

“We vehemently reject the accusation of share price manipulation,” a spokesman for Porsche said. “The ones responsible are those that speculated with huge sums of money on a falling Volkswagen share price.”

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Porsche’s statement on Sunday revealed that it had raised its direct stake to 42.6 percent, held a further 31.5 percent in cash-settled stock options and that it intended to increase its holding in the world’s third largest carmaker to 75 percent next year.

It said it was announcing its plans because the number of short positions in VW were considerably higher than it expected and it consequently wanted to give investors the chance to unwind their bets “without haste and without greater risk.”

Around 12.8 percent of Volkswagen’s entire market capitalization was on loan as of October 25, the most recent day for which data was available, according to financial market data consultant dataexplorers.com. This compared with an average 5 percent for all DAX stocks.

The “mother of all short squeezes,” as one analyst phrased it, led to an investor outcry alleging that they were duped by Porsche.

Dealers said those traders who had sold borrowed VW shares in the hope of buying them back at lower prices had been panicked by the announcement of Porsche’s holding.

“Someone must have been very desperate to get a hold of the stock, so there will be a big surprise at some point who will have all these losses -- because someone must have lost a lot of money,” said Christian Schick, head of portfolio management in Germany for Fortis Investments.

Shares in Morgan Stanley MS.N, Goldman Sachs Group Inc GS.N and France's Societe Generale SOGN.PA all tumbled on Tuesday with traders saying there was speculation that the banks might be caught on the wrong side of trades involving Volkswagen.

Goldman declined to comment, but people inside the company said it had no Volkswagen losses, while a Morgan Stanley spokesman said that the company has no exposure to the automaker. SocGen could not immediately be reached for comment, but earlier on Tuesday said it was sticking with its third-quarter earnings forecast.

VOLKSWAGEN DAX WEIGHTING?

Shares in VW were up 45 percent at 689.9 euros by 1604 GMT, after tripling at one point in the previous session.

This meant they were trading at around 63 times expected earnings for 2009, at a massive premium to rivals such as Toyota Motor Corp 7203.T and Daimler DAIGn.DE.

Analysts and traders said the stampede was historic for German large caps, but they could foresee VW shares continuing to rise or stay at current levels.

“The problem is, from a fundamental point of view, shares are really overvalued. But when the short squeeze comes to an end, there are not enough shares available to bring the share price back down,” said one Frankfurt-based analyst.

Despite the massive rise in VW shares and talk of little free float remaining, the Frankfurt Stock Exchange said it did not plan any changes in the German blue-chip DAX index.

But Wolfgang Gerke, a member of the Frankfurt Stock Exchange’s Exchange Council, told manager magazin’s online portal that VW stock should be reweighted on the German DAX bluechip index as soon as possible.

When asked about the current, nearly 17 percent weighting that Volkswagen’s stock has on the gauge, Gerke said: “Deutsche Boerse needs to act now and reduce VW’s weighting on the basis of its considerably lowered freefloat.”

The Finance Ministry declined to comment on the rise in the Volkswagen share price and the Economy Ministry did not respond to multiple calls seeking comment.