Publication Type

Conference Paper

Version

submittedVersion

Publication Date

11-2017

Abstract

This paper systematically examines the impact of nine popular arbitrage costs measures on cross-sectional mispricing based on ten well-known and robust anomalies. We show that binding arbitrage barriers slowly change over time. In early years with few publications documenting return anomalies, arbitrage costs have tiny impact even though mispricing is present. As anomalies become more widely known, arbitrage costs impact mispricing substantially. Arbitrage risk, ambiguity of fundamental value, round-trip broker’s commission plus bid-ask spreads, and stock loan supply are binding on arbitrageurs. Only arbitrage risk is binding if larger cap stocks are emphasized. In recent years when market quality improves and some arbitrageurs become more creative, only round-trip broker’s commission plus bid-ask spreads and stock loan supply remain binding on arbitrageurs. If larger cap stocks are emphasized, arbitrage costs do not matter at all because there is no longer mispricing. An empirical arbitrage costs model based on these simple dynamics subsumes annually-varying principal components of arbitrage costs in affecting mispricing. Incorporating our findings into future capital market efficiency research would mitigate type I and II errors in empirical tests applying the limits-to-arbitrage argument.

Keywords

Arbitrage costs, Arbitrage risk, Information uncertainty, Transaction costs, Mispricing

Discipline

Finance and Financial Management

Research Areas

Finance

Publication

Asian Finance Association Conference 2017, July 6-8, Seoul; Deutche Bank Global Quant Conference 2017, November 13-15

First Page

1

Last Page

65

Identifier

10.2139/ssrn.2842514

City or Country

Hong Kong

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.2139/ssrn.2842514

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