How Constraining Are Limits to Arbitrage?

57 Pages Posted: 22 Aug 2014

See all articles by Alexander Ljungqvist

Alexander Ljungqvist

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

Wenlan Qian

National University of Singapore - NUS Business School

Multiple version iconThere are 2 versions of this paper

Date Written: June 18, 2014

Abstract

We examine to what extent institutional frictions such as short-sale constraints deter entry into informational arbitrage ex ante and reduce informational efficiency ex post. We focus on small arbitrageurs who target hard-to-short companies with correspondingly high potential for overvaluation. Being price-takers, they cannot correct mispricing through trading. Instead, they reveal their information to the market in an effort to induce long investors to sell so that prices fall. As long as the information is credible, revealing it accelerates price discovery and so reduces noise trader risk. By implication, even extreme short-sale constraints need not constrain arbitrage, as is often assumed.

Keywords: Informational arbitrage, limits to arbitrage; short sale constraints; mispricing; short selling; activist short sellers; trading strategies; behavioral finance; market efficiency

JEL Classification: G12, G14, G23, G2

Suggested Citation

Ljungqvist, Alexander and Qian, Wenlan, How Constraining Are Limits to Arbitrage? (June 18, 2014). 27th Australasian Finance and Banking Conference 2014 Paper. Available at SSRN: https://ssrn.com/abstract=2459760 or http://dx.doi.org/10.2139/ssrn.2356414

Alexander Ljungqvist

Stockholm School of Economics ( email )

111 60 Stockholm
Sweden

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

Wenlan Qian (Contact Author)

National University of Singapore - NUS Business School ( email )

15 Kent Ridge Drive
Singapore 117592, 119245
Singapore
(65) 65163015 (Phone)

HOME PAGE: http://sites.google.com/site/wenlanqian/

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