Arbitrage Trading: The Long and the Short of It
Review of Financial Studies (RFS), Vol. 32, No. 4, April 2019, pp. 1608–1646
82 Pages Posted: 20 Feb 2015 Last revised: 27 Sep 2019
Date Written: June 5, 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 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: Suggested Citation