The Role of Limits to Arbitrage and the Asset Growth Anomaly
F.Y. Eric C. Lam
Hong Kong Baptist University (HKBU) - Department of Finance and Decision Sciences; Hong Kong University of Science & Technology (HKUST) - Department of Finance
K. C. John Wei
Hong Kong University of Science & Technology (HKUST) - Department of Finance
In this paper, we hypothesize that if the negative relationship between asset growth and stock returns is due to mispricing, it should be more pronounced and more persistent when there are more severe limits to arbitrage. The empirical evidence supports our hypothesis. Our findings are not due to conventional risks, firm characteristics, equity issuance, or idiosyncratic risk. In addition, the role of limits to arbitrage in the asset growth anomaly is not a manifestation of liquidity risk and is not simply ex-post justified by trading expenses. Our results appear to support the limits-to-arbitrage argument proposed by Shleifer and Vishny (1997).
Number of Pages in PDF File: 61
Keywords: Asset growth, Capital investment, Cross-section of stock returns, Limits to arbitrage
JEL Classification: G14, G31, M41, M42
Date posted: March 17, 2009 ; Last revised: April 9, 2011
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