The Growth and Limits of Arbitrage: Evidence from Short Interest

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The Growth and Limits of Arbitrage: Evidence from Short Interest

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Title: The Growth and Limits of Arbitrage: Evidence from Short Interest
Author: Hanson, Samuel Gregory; Sunderam, Aditya Vikram

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Citation: Hanson, Samuel G., and Adi Sunderam. "The Growth and Limits of Arbitrage: Evidence from Short Interest." Review of Financial Studies (forthcoming). (Internet Appendix: http://www.people.hbs.edu/shanson/shortint_IA_20130814_FINAL.pdf)
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Abstract: We develop a novel methodology to infer the amount of capital allocated to quantitative equity arbitrage strategies. Using this methodology, which exploits time-variation in the cross section of short interest, we document that the amount of capital devoted to value and momentum strategies has grown significantly since the late 1980s. We provide evidence that this increase in capital has resulted in lower strategy returns. However, consistent with theories of limited arbitrage, we show that strategy-level capital flows are influenced by past strategy returns as well as strategy return volatility, and that arbitrage capital is most limited during times when strategies perform best. This suggests that the growth of arbitrage capital may not completely eliminate returns to these strategies.
Other Sources: http://rfs.oxfordjournals.org/
Terms of Use: This article is made available under the terms and conditions applicable to Open Access Policy Articles, as set forth at http://nrs.harvard.edu/urn-3:HUL.InstRepos:dash.current.terms-of-use#OAP
Citable link to this page: http://nrs.harvard.edu/urn-3:HUL.InstRepos:11148066
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