Costly Arbitrage and Skewness Pricing: Evidence from First-day Price Limit Reform in China

Abstract

We examine the impact of a reform of China's stock market that limits first-day price movements on skewness pricing. We document that the reform causes a significant increase in the impact of IPOs' expected skewness on both their initial returns and trading interference effect, especially for IPO firms that are sensitive to the limitations imposed by price limits. There is also some evidence that the skewness pricing effect persists much longer along the idiosyncratic dimension than along the market-wide dimension. The results are consistent with the notion that price limits favor delayed arbitrage, thereby positively affecting skewness pricing.

Keywords: skewness pricing; price limit; IPOs; limits to arbitrage; China

JEL Classification: G41; G11