We test the limits of arbitrage argument for the survival of irrationality-induced financial anomalies by sorting securities on their individual residual variability as a proxy for idiosyncratic risk – a commonly asserted limit to arbitrage – and comparing the strength of anomalous returns in low versus high residual variability portfolios. We find no support for the limits of arbitrage argument to explain undervaluation anomalies (small value stocks, value stocks generally, recent winners, and positive earnings surprises) but strong support for the limits of arbitrage argument to explain overvaluation anomalies (small growth stocks, growth stocks generally, recent losers, and negative earnings surprises). Other tests also fail to support the limits of arbitrage argument for the survival of overvaluation anomalies and suggest that at least some of the factor premiums for size, book-to-market, and momentum are unrelated to irrationality protected by limits to arbitrage

We are delighted to announce that the winner of the 2010 Deutsche Bank Best Paper Award is: “Corporate Governance Externalities” by Viral Acharya and Paolo Volpin which appeared in issue 1 of Volume 14 and was voted by the editorial board as the best article published in the last four issues of the Review of Finance. The two runners-up for the award were: “Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt” by Jens Hilscher and Yves Nosbusch and “The Limits of the Limits of Arbitrage” by Alon Brav, J.B. Heaton and Si Li The awards were presented at the 2010 annual meeting of the European Finance Association in Frankfurt on August 27th. We are grateful to the Deutsche Bank Foundation for sponsoring this award