Arbitrage Trading: The Long and the Short of It

Review of Financial Studies, Forthcoming

82 Pages Posted: 20 Feb 2015 Last revised: 26 Sep 2018

See all articles by Yong Chen

Yong Chen

Texas A&M University - Department of Finance

Zhi Da

University of Notre Dame - Mendoza College of Business

Dayong Huang

University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics

Date Written: June 5, 2018

Abstract

We examine net arbitrage trading (NAT) measured by the difference between quarterly abnormal hedge fund holdings and abnormal short interest. NAT strongly predicts stock returns in the cross section. Across 10 well-known stock anomalies, abnormal returns are realized only among stocks experiencing large NAT. Exploiting Regulation SHO that facilitated short-selling for a random group of stocks, we present causal evidence that NAT has stronger return predictability among stocks facing greater limits-to-arbitrage. We also find large returns for anomalies that arbitrageurs chose to exploit despite capital constraints during the 2007-2009 financial crisis. Finally, we confirm our main findings using daily data.

Keywords: Arbitrage trading, hedge funds, short selling, stock anomalies, limits to arbitrage

JEL Classification: G11, G23

Suggested Citation

Chen, Yong and Da, Zhi and Huang, Dayong, Arbitrage Trading: The Long and the Short of It (June 5, 2018). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2566802 or http://dx.doi.org/10.2139/ssrn.2566802

Yong Chen (Contact Author)

Texas A&M University - Department of Finance ( email )

360 Wehner Building
College Station, TX 77843-4218
United States

Zhi Da

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

Dayong Huang

University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics ( email )

401 Bryan Building
Greensboro, NC 27402-6179
United States

HOME PAGE: http://sites.google.com/a/uncg.edu/dayong-huang/

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