Self-Imposed Limits to Arbitrage

Abstract

A multi-billion-dollar, multi-year discrepancy between two identical share classes of HSBC did not suffer from traditional external limits to arbitrage such as transactions costs and risk measures. One possible explanation is that self-imposed limits to arbitrage (SILTA) such as internal restrictions on position size allowed persistent mispricings. SILTA predicts a novel negative relation between relative volume and relative price. This prediction from SILTA holds not only for HSBC, but also other large mispriced pairs such as 3Com/Palm and Royal Dutch-Shell. Indeed, the implied overall maximum position size of arbitrageurs is roughly constant at one hundred days of trading volume for various mispriced pairs spanning different time periods and countries, suggesting SILTA as a possible explanation for all of them.

Keywords: limits to arbitrage, dual shares, arbitrage, Royal Dutch-Shell, pairs, HSBC

JEL Classification: G14, G15, G12, G10, G11, G20