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The Limits to Arbitrage and the Low-Volatility Anomaly

Xi Li

Hong Kong University of Science & Technology

Rodney N Sullivan

AQR Capital Management

Luis García-Feijóo

Florida Atlantic University - Department of Finance

October 16, 2013

Financial Analysts Journal, Forthcoming

We show that over a long study period (1963-2010), the existence and trading efficacy of the well-known low-volatility stock anomaly are more limited than widely believed. For example, we find that the anomalous returns are not found within equal weighted long-short (low minus high risk) portfolios. Within value-weighted portfolios, the existence of alpha is largely eliminated when omitting low priced (less than $5) stocks. Furthermore, extracting any excess returns associated with a long-short portfolio is meaningfully hampered by high transaction costs reflecting the finding that the abnormal returns are concentrated among low liquidity and smaller stocks. Adding to the challenge, the anomalous excess returns quickly reverse requiring traders to rebalance frequently in attempting to extract profits, thus amplifying liquidity needs. Our findings are unchanged for various approaches to measuring the low-volatility anomaly.

Number of Pages in PDF File: 31

Keywords: low-volatility, arbitrage

Accepted Paper Series

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Date posted: January 12, 2011 ; Last revised: October 21, 2013

Suggested Citation

Li, Xi and Sullivan, Rodney N and García-Feijóo, Luis, The Limits to Arbitrage and the Low-Volatility Anomaly (October 16, 2013). Financial Analysts Journal, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1738316 or http://dx.doi.org/10.2139/ssrn.1738316

Contact Information

Xi Li
Hong Kong University of Science & Technology ( email )
Clearwater Bay
Hong Kong
Rodney N Sullivan (Contact Author)
AQR Capital Management ( email )
Two Greenwich Plza
Greenwich, CT 06830
United States
HOME PAGE: http://www.aqr.com/Home.aspx
Luis Garcia-Feijoo
Florida Atlantic University - Department of Finance ( email )
777 Glades Rd
Boca Raton, FL 33431
United States
954-236-1239 (Phone)
Feedback to SSRN

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References:  38
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