Limits to Arbitrage: The Case of Single Stock Futures and Spot Prices
26 Pages Posted: 28 Mar 2015 Last revised: 30 Mar 2015
Date Written: March 27, 2015
Market frictions such as transactions costs, funding constraints and short selling constraints limit arbitrage, but these frictions affect different stocks differently. Using intraday data on a liquid single stock futures and spot market, we examine the effect of these frictions on arbitrage efficiency of the two markets. We find evidence of significant cross-sectional variation in the size and asymmetricity of no-arbitrage bands. To the extent that market frictions affect all stocks similarly, commonality in the size of no-arbitrage bands is expected. We find that 17% of variation in the size of no-arbitrage bands is explained by the first principal component. Changes in funding liquidity is a key factor that determines variation in the common component.
Keywords: Limits to arbitrage, Mispricing, No-arbitrage bands, Short-selling constraints, Transactions costs, Funding constraints
JEL Classification: G13, G14
Suggested Citation: Suggested Citation