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 and 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.

Most home mortgages in the United States are fixed-rate loans with an embedded prepayment option. When long-term rates decline, the effective duration of mortgage-backed securities (MBS) falls due to heightened refinancing expectations. I show that these changes in MBS duration function as large-scale shocks to the quantity of interest rate risk that must be borne by professional bond investors. I develop a simple model in which the risk tolerance of bond investors is limited in the short run, so these fluctuations in MBS duration generate significant variation in bond risk premia. Specifically, bond risk premia are high when aggregate MBS duration is high. The model offers an explanation for why long-term rates could appear to be excessively sensitive to movements in short rates and explains how changes in MBS duration act as a positive-feedback mechanism that amplifies interest rate volatility. I find strong support for these predictions in the time series of US government bond returns.

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 and 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.