The Race to Exploit Anomalies and the Cost of Slow Trading

Abstract

This study explores how arbitrage capital reshapes out-of-sample returns and volume of trade. Studying 71 anomalies, we show that the discovery of an anomaly creates a contrarian effect on the general decay in returns. A consistent volume effect reinforces the arbitrage capital explanation. The effect duration has been shortened and starts earlier in more recent years, along with the reduction in costs of arbitrage. Also consistent with the limits-to-arbitrage hypothesis, the differences in long-side and short-side portfolios diminish in more recent years. The long-lasting effect indicates a persistent mispricing component in anomalies.

Keywords: market efficiency, cross-section anomalies, arbitrage capital, asset mispricing, contrarian return effect

JEL Classification: G12, G14