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A Generalized Portfolio Approach to Limited Risk Arbitrage: Evidence from the MSCI Global Index Change

45 Pages Posted: 27 Feb 2007  

Harald Hau

University of Geneva - Geneva Finance Research Institute; Swiss Finance Institute; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2007

Abstract

We develop a framework to explore the asset pricing implications of simultaneous supply shocks in multiple assets in a setting with limits-to-arbitrage. The portfolio approach in Greenwood (2005) is generalized to allow for asymmetric information and therefore net positions of arbitrageurs against uninformed liquidity providers. We predict that announcement returns are not only positively proportional to the asset premium change of each stock (like in Greenwood), but also negatively proportional to the risk contribution of the arbitrage position captured by the product of the squared return covariance matrix and the vector of supply changes. The redefinition of the MSCI international equity index in 2001 and 2002 provides a powerful event study to test these predictions. We find strong evidence in favor of our generalized model of limited arbitrage. Moreover, asset pricing effects of weight changes across stocks are quantitatively similar for domestic and foreign stocks. MSCI stocks are therefore priced globally and not locally.

Keywords: Limited Arbitrage, Index Revision, Asset Pricing

JEL Classification: G11, G14, G15

Suggested Citation

Hau, Harald, A Generalized Portfolio Approach to Limited Risk Arbitrage: Evidence from the MSCI Global Index Change (March 1, 2007). Available at SSRN: https://ssrn.com/abstract=965186 or http://dx.doi.org/10.2139/ssrn.965186

Harald Hau (Contact Author)

University of Geneva - Geneva Finance Research Institute ( email )

40, Boulevard du Pont d'Arve
CH 1211 Geneva 4
Geneva
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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