Limits to Arbitrage: The Case of Single Stock Futures and Spot Prices

26 Pages Posted: 28 Mar 2015 Last revised: 30 Mar 2015

See all articles by Nidhi Aggarwal

Nidhi Aggarwal

Indian Institute of Management (IIMU), Udaipur

Date Written: March 27, 2015

Abstract

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

Aggarwal, Nidhi, Limits to Arbitrage: The Case of Single Stock Futures and Spot Prices (March 27, 2015). Available at SSRN: https://ssrn.com/abstract=2585876 or http://dx.doi.org/10.2139/ssrn.2585876

Nidhi Aggarwal (Contact Author)

Indian Institute of Management (IIMU), Udaipur ( email )

Mohanlal Sukhadia University Campus
Udaipur, Rajasthan 313001
India

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