Mispricing and Costly Arbitrage

Journal of Investment Management (JOIM), First Quarter 2010

Posted: 13 Mar 2010 Last revised: 3 Jun 2010

See all articles by Ronnie Sadka

Ronnie Sadka

Boston College - Carroll School of Management

Anna Scherbina

Brandeis University

Multiple version iconThere are 2 versions of this paper

Date Written: March 10, 2010

Abstract

The equilibrium magnitude of mispricing can be no greater than the cost of arbitraging it away. Yet, mispricing typically arises when the uncertainty about a firm is high, which is precisely when the stock’s liquidity is low. This is the case for stocks with high analyst disagreement about future earnings. These stocks tend to be overpriced, with prices converging down as the uncertainty about earnings is resolved, but the stocks’ low liquidity suggests that transaction costs significantly reduce the potential arbitrage profits. Positive shocks to market-wide liquidity reduce arbitrage costs and accelerate the convergence of prices to fundamentals.

Suggested Citation

Sadka, Ronnie and Scherbina, Anna D., Mispricing and Costly Arbitrage (March 10, 2010). Journal of Investment Management (JOIM), First Quarter 2010. Available at SSRN: https://ssrn.com/abstract=1568313

Ronnie Sadka (Contact Author)

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Anna D. Scherbina

Brandeis University ( email )

415 South Street
Waltham, MA 02453
United States

HOME PAGE: http://sites.google.com/a/brandeis.edu/anna-scherbina/

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