Comovement in Arbitrage Limits

51 Pages Posted: 24 Sep 2018 Last revised: 11 Sep 2020

See all articles by Jianan Liu

Jianan Liu

Mingshi Investment Management; University of Hong Kong

Date Written: May 12, 2019

Abstract

Estimates of mispricing, such as deviations from no-arbitrage relations, strongly comove across five financial markets. One common component---the arbitrage gap---explains the majority of variability in mispricing estimates for futures, Treasury securities, foreign exchange, and options. Prominent equity anomalies also comove significantly with the arbitrage gap. Variables affecting arbitrage capital availability, such as the TED spread and hedge fund flows and returns, explain two-thirds of the arbitrage gap’s variation. During periods of tighter capital constraints, the comovement in mispricings becomes stronger. The findings support theoretical predictions that common sources of funding shocks can cause comovement in mispricings across markets.

Keywords: Limits of arbitrage, anomalies, market efficiency, hedge funds

JEL Classification: G12, G14, G23

Suggested Citation

Liu, Jianan, Comovement in Arbitrage Limits (May 12, 2019). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=3242862 or http://dx.doi.org/10.2139/ssrn.3242862

Jianan Liu (Contact Author)

Mingshi Investment Management ( email )

8 Queens Road Central
Hong Kong Island
Hong Kong
Hong Kong

University of Hong Kong

Pokfulam Road
Hong Kong, Hong Kong
China

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