We examine how institutional ownership structure gives rise to limits to arbitrage through its impact on short-sale constraints. Stocks with lower, more concentrated, short-term, and less passive ownership exhibit lower lending supply, higher costs of shorting, and higher arbitrage risk. These constraints limit the ability of arbitrageurs to take short positions and delay the correction of mispricing. Stocks with more concentrated ownership exhibit smaller announcement day reactions, larger post-earnings announcement drift, and an additional negative abnormal return of -0.47% in the week following a positive shorting demand shock

We examine the causal effect of limits to arbitrage on 11 well‐known asset pricing anomalies using the pilot program of Regulation SHO, which relaxed short‐sale constraints for a quasi‐random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios constructed with pilot stocks during the pilot period. The pilot program reduced the combined anomaly long–short portfolio returns by 72 basis points per month, a difference that survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios

This paper characterizes equilibria in the Shleifer-Vishny model of limits of arbitrage. To prove existence, one has to consider types of equilibria ignored by Shleifer and Vishny, even if one adopts their parameter restrictions. For example, the only equilibrium may be one in which maximization of expected wealth requires an “all-or-nothing” investment strategy, with intermediate investment levels being strictly unprofitable. If one goes beyond Shleifer and Vishny's parameter restrictions, multiple equilibria may arise, and equilibrium selection may be governed by sunspots. Moreover, there may exist an equilibrium in which the asset price returns to fundamentals despite worsening noise trader sentiment

“Limits of Arbitrage” theories hypothesize that the marginal investor in a particular asset market is a specialized arbitrageur rather than a diversified representative investor. We examine the mortgage‐backed securities (MBS) market in this light. We show that the risk of homeowner prepayment, which is a wash in the aggregate, is priced in the MBS market. The covariance of prepayment risk with aggregate wealth implies the wrong sign to match the observed prices of prepayment risk. The price of risk is better explained by a kernel based on MBS market‐wide specific risk, consistent with the specialized arbitrageur hypothesis

Government regulations on housing flippers target their high capital gains but ignore their risk-sharing function: rational arbitrageurs reduce market return volatility borne by other participants while undertaking high idiosyncratic risk. Regulations that tighten the limits of arbitrage in housing markets can adversely affect market efficiency by blocking this risk-sharing function. Using comprehensive housing transaction records in Hong Kong from 1993 to 2021, we find although flippers obtain higher annual capital gain returns than long-term buyers by 8.76 percentage points, they undertake substantially higher idiosyncratic risk due to its unique downward-sloping term structure. Only experienced flippers, who have at least two prior purchase experiences and constitute less than 20% of the flippers, outperform long-term buyers in risk-adjusted returns. Following the enactment of an anti-speculation policy that decreases the share of flippers by 14.2 percentage points in one year, the market return volatility of the entire housing market increases by 21.9

This paper shows that authorized participants’ (APs) regulatory constraints weakened the arbitrage relationship between bond ETFs’ primary market activity and their premia during the market turmoil triggered by the dash-for-cash episode in March 2020. Arbitrage activity weakened more severely when those APs with a history of creating or redeeming an ETF’s shares had low regulatory capital ratios, consistent with persistence in arbitrage activity. The results also reveal that the direction of prior arbitrage activity matters, and show that the decline in arbitrage intensity was especially pronounced for ETFs holding less liquid bonds, whose lead market makers had lower regulatory capital ratios, and for those associated with non-bank-affiliated APs. Finally, the paper provides a novel estimate of the elasticity of primary market activity to ETF premia, contributing to the literature on limits to arbitrage and intermediary frictions

Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital and is typically risky. Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances when prices diverge far from fundamental values. The model also suggests where anomalies in financial markets are likely to appear, and why arbitrage fails to eliminate them

Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital, and is typically risky. Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances, when prices diverge far from fundamental values. The model also suggests where anomalies in financial markets are likely to appear, and why arbitrage fails to eliminate them

We examine the factors underlying the presence of earnings announcement premia. We find that the premia persist beyond the sample period examined in prior studies (ending in 1988), although they decline in magnitude after 1988. Further, premia are lower on the expected than the actual earnings announcement dates. We document that increases in voluntary disclosures result in lower premia, despite the increase in return volatility over time. Finally, our evidence suggests that the premia are not completely eliminated because of the costs of arbitrage

We document that short-horizon pricing discrepancies across firms' equity and credit markets are common and that an economically significant proportion of these are anomalous, indicating a lack of integration between the two markets. Proposing a statistical measure of market integration, we investigate whether equity–credit market integration is related to impediments to arbitrage. We find that time variation in integration across a firm's equity and credit markets is related to firm-specific impediments to arbitrage such as liquidity in equity and credit markets and idiosyncratic risk. Our evidence provides a potential resolution to the puzzle of why Merton model hedge ratios match empirically observed stock-bond elasticities (Schaefer and Strebulaev, 2008) and yet the model is limited in its ability to explain the integration between equity and credit markets (Collin-Dufresne, Goldstein, and Martin, 2001