Systematic Limited Arbitrage and the Cross-Section of Stock Returns: Evidence from Exchange Traded Funds

46 Pages Posted: 6 Nov 2014 Last revised: 12 Jul 2016

See all articles by Jared DeLisle

Jared DeLisle

Utah State University

Brian McTier

Washington State University

Adam R Smedema

University of Northern Iowa

Date Written: March 2, 2015

Abstract

We propose a parsimonious, comprehensive proxy for innovations in limited arbitrage: the divergence between the return on an ETF and the return on the underlying net asset value. Consistent with a common component, we confirm limited arbitrage risk-factors, LAF, constructed from return divergence spanning four asset classes are correlated. Consistent with well-known factors that limit arbitrage, increased volatility and market illiquidity, we find that equity LAFs are negatively priced in the cross-section of stock returns. However, our pricing tests confirm that LAFs also provide pricing information beyond well-known limits to arbitrage. Overall, our findings suggest that limited arbitrage risk is priced and LAF is a relevant risk-factor.

Keywords: Limited Arbitrage, Asset Pricing, ICAPM, ETF

JEL Classification: G12

Suggested Citation

DeLisle, Jared and McTier, Brian and Smedema, Adam R, Systematic Limited Arbitrage and the Cross-Section of Stock Returns: Evidence from Exchange Traded Funds (March 2, 2015). Journal of Banking and Finance, 2016, Vol. 70, 118-136. Available at SSRN: https://ssrn.com/abstract=2492260 or http://dx.doi.org/10.2139/ssrn.2492260

Jared DeLisle

Utah State University ( email )

Logan, UT 84322
United States
435-797-0885 (Phone)

Brian McTier (Contact Author)

Washington State University ( email )

Wilson Rd.
College of Business
Pullman, WA 99164
United States

Adam R Smedema

University of Northern Iowa ( email )

Cedar Falls, IA 50614
United States

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