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Price Impact Costs and the Limit of Arbitrage

EFA 2002 Berlin Meetings Presented Paper; Yale ICF Working Paper No. 00-66

60 Pages Posted: 10 Jul 2002  

Zhiwu Chen

University of Hong Kong; Yale University - International Center for Finance; Zebra Capital Management, LLC

Werner Stanzl

Yale University - International Center for Finance

Masahiro Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Date Written: February 26, 2002

Abstract

This paper investigates whether one can profit from the size, book-to-market, or momentum anomaly, when price-impact costs are taken into account. A non-linear price-impact function is individually estimated for 5173 stocks to assess the magnitude of trading costs. Compared to constant proportional transaction costs (as typically assumed in the literature), a concave price-impact function tends to assign a higher impact cost to mid-size trades and a lower impact to large-size trades. We implement long-short arbitrage strategies based on each such anomaly, and estimate the maximal fund size possible before excess returns become negative. For all anomalies, the maximal fund sizes are small in order to remain profitable. Markets are therefore bounded-rational: price-impact costs deter agents from exploiting the anomalies.

Keywords: Stock market anomaly, Price-impact function, Arbitrage, Fund size limit

JEL Classification: G1

Suggested Citation

Chen, Zhiwu and Stanzl, Werner and Watanabe, Masahiro, Price Impact Costs and the Limit of Arbitrage (February 26, 2002). EFA 2002 Berlin Meetings Presented Paper; Yale ICF Working Paper No. 00-66. Available at SSRN: https://ssrn.com/abstract=302065 or http://dx.doi.org/10.2139/ssrn.302065

Zhiwu Chen

University of Hong Kong ( email )

Pokfulam Road
Hong Kong
China

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520-8200
United States
203-432-5948 (Phone)
203-432-6970 (Fax)

Zebra Capital Management, LLC ( email )

612 Wheelers Farms Road
Milford, CT 06461
United States

Werner Stanzl (Contact Author)

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520-8200
United States
203-436-0666 (Phone)
203-436-0630 (Fax)

HOME PAGE: http://som.yale.edu/~ws69

Masahiro Watanabe

University of Alberta - School of Business ( email )

School of Business - FMS
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-7343 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.ualberta.ca/~masa/

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

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