Limits to Arbitrage, Investor Sentiment, and Factor Returns in International Government Bond Markets
Economic Research-Ekonomska Istraživanja, Forthcoming
22 Pages Posted: 28 Feb 2019
Date Written: April 23, 2018
The perspective of behavioral finance is that anomalies in the cross-section of returns are driven by mispricing that arises from investor irrationality that cannot be easily arbitraged away. In this study, we examine the implications of this for international government bond markets. Using data for 25 countries for the years 1992–2015, we replicate multiple factor strategies that represent four major return drivers: defensive (low-risk), carry, value and momentum. We investigate the relationships between the performance of these strategies and market-wide measures of limits to arbitrage and investor sentiment. We find that the defensive strategy performs best during tight arbitrage conditions whereas severe limits to arbitrage negatively affect momentum profits.
Keywords: international markets, government bonds, anomalies, limits to arbitrage, investor sentiment, return predictability
JEL Classification: G11, G12, G15
Suggested Citation: Suggested Citation