Anomaly Discovery and Arbitrage Trading

48 Pages Posted: 2 May 2014 Last revised: 5 Oct 2018

See all articles by Xi Dong

Xi Dong

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Qi Liu

Peking University - Department of Finance

Lei Lu

Asper School of Business, University of Manitoba

Bo Sun

Board of Governors of the Federal Reserve System - Division of International Finance

Hongjun Yan

DePaul University

Date Written: September 28, 2018

Abstract

Our model of anomaly discovery has implications for both asset prices and arbitrageurs' trading. Consistent with existing evidence, the discovery of an anomaly reduces its magnitude. Our evidence based on 99 anomalies is consistent with new predictions that the discovery of an anomaly reduces the correlation between the returns its deciles 1 and 10, leading to diversification benefits for passive investors. These effects become linked to the aggregate trading of hedge funds only after discovery. Hedge funds increase (reverse) their positions in exploiting anomalies when their aggregate wealth increases (decreases), further suggesting that these discovery effects operate through arbitrage trading.

Keywords: Anomaly, Arbitrage, Discovery, Arbitrageur-based asset pricing.

JEL Classification: G11, G23

Suggested Citation

Dong, Xi and Liu, Qi and Lu, Lei and Sun, Bo and Yan, Hongjun, Anomaly Discovery and Arbitrage Trading (September 28, 2018). Available at SSRN: https://ssrn.com/abstract=2431498 or http://dx.doi.org/10.2139/ssrn.2431498

Xi Dong

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

HOME PAGE: http://aux.zicklin.baruch.cuny.edu/dong/

Qi Liu

Peking University - Department of Finance ( email )

Beijing
China

Lei Lu

Asper School of Business, University of Manitoba ( email )

181 Freedman Crescent
Winnipeg, Manitoba R3T 5V4
Canada

Bo Sun

Board of Governors of the Federal Reserve System - Division of International Finance ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Hongjun Yan (Contact Author)

DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/view/hongjunyan

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