Limits of Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data

54 Pages Posted: 19 May 2017 Last revised: 23 May 2017

Bastian von Beschwitz

Board of Governors of the Federal Reserve System

Sandro Lunghi

Inalytics Limited

Daniel Schmidt

HEC Paris - Finance Department

Date Written: May 12, 2017

Abstract

We exploit detailed transaction and position data for a sample of long-short equity hedge funds to document new facts about the trading activity of sophisticated investors. We find that the initiation of both long and short positions is associated with significant abnormal returns, suggesting that the hedge funds in our sample possess investment skill. In contrast, the closing of long and short positions is followed by return continuation, implying that hedge funds close their positions too early and “leave money on the table.” As we demonstrate with a simple model, this behaviour can be explained by hedge funds being (risk) capital constrained and facing position monitoring costs. Consistent with our model, we document that the return continuation following closing orders is more pronounced when these constraints become more binding (e.g., after negative fund returns or increases in volatility).

Keywords: Hedge Funds, Short Selling, Profitability, Limits of Arbitrage

JEL Classification: G11, G12, G14, G15

Suggested Citation

von Beschwitz, Bastian and Lunghi, Sandro and Schmidt, Daniel, Limits of Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data (May 12, 2017). Available at SSRN: https://ssrn.com/abstract=2970756 or http://dx.doi.org/10.2139/ssrn.2970756

Bastian Von Beschwitz (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Sandro Lunghi

Inalytics Limited ( email )

Croydon
United Kingdom

Daniel Schmidt

HEC Paris - Finance Department ( email )

France
0652678597 (Phone)

HOME PAGE: http://daniel-schmidt.eu

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