The Limits to Arbitrage and the Low-Volatility Anomaly

31 Pages Posted: 12 Jan 2011 Last revised: 19 Oct 2014

Xi Li

Hong Kong University of Science & Technology (HKUST)

Rodney N Sullivan

AQR Capital Management

Luis García-Feijóo

Florida Atlantic University - Department of Finance

Date Written: October 16, 2013

Abstract

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.

Keywords: low-volatility, arbitrage

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 70 (1), 52-64, January/February 2014.. Available at SSRN: https://ssrn.com/abstract=1738316 or http://dx.doi.org/10.2139/ssrn.1738316

Xi Li

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon
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)

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