Costly Arbitrage and Idiosyncratic Risk: Evidence from Short Sellers

Posted: 23 May 2013 Last revised: 30 May 2013

See all articles by Ying Duan

Ying Duan

Simon Fraser University (SFU) - Beedie School of Business

Gang Hu

Hong Kong Polytechnic University - School of Accounting and Finance

R. David McLean

Georgetown University - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: May 22, 2009

Abstract

Previous studies have shown that high short interest stocks have low subsequent returns. We test whether the persistence of this effect is due to costs limiting arbitrage. The arbitrage cost that we focus on is idiosyncratic risk which, regardless of the arbitrageur’s level of diversification, deters arbitrage activity. Consistent with costly arbitrage, we find that among high short interest stocks a one standard deviation increase in idiosyncratic risk predicts a more than 1% decline in monthly returns. Moreover, idiosyncratic risk does not predict returns across low short interest stocks, and short interest does not predict low returns across low idiosyncratic risk stocks. Our results are robust to commonly used proxies for both transaction costs and short sale constraints.

Suggested Citation

Duan, Ying and Hu, Gang and McLean, R. David, Costly Arbitrage and Idiosyncratic Risk: Evidence from Short Sellers (May 22, 2009). Journal of Financial Intermediation, Vol. 19, No. 4, 2010; University of Alberta School of Business Research Paper No. 2013-204. Available at SSRN: https://ssrn.com/abstract=2268727

Ying Duan (Contact Author)

Simon Fraser University (SFU) - Beedie School of Business ( email )

8888 University Drive
Burnaby, British Colombia V5A 1S6
Canada

Gang Hu

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

M1038, Li Ka Shing Tower
Hung Hom, Kowloon
Hong Kong
(852) 3400 8455 (Phone)

HOME PAGE: http://ganghu.org

R. David McLean

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC Washington DC 20057
United States

Register to save articles to
your library

Register

Paper statistics

Abstract Views
376
PlumX Metrics