Arbitrage Trading: The Long and the Short of It
75 Pages Posted: 20 Feb 2015 Last revised: 15 Jan 2018
Date Written: January 12, 2018
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 a broad set of stock anomalies, abnormal returns are realized only among stocks experiencing strong NAT. Consistent with the existence of limits-to-arbitrage, NAT does not correct mispricing completely and instantaneously. Exploiting the Regulation SHO that facilitated short selling for a random set of stocks, we present causal evidence that limits-to-arbitrage affect NAT’s ability to correct mispricing. We also confirm these findings using daily data.
Keywords: Arbitrage trading, hedge fund holdings, short interest, stock anomaly, limits to arbitrage
JEL Classification: G11, G23
Suggested Citation: Suggested Citation