Liquidity, Frictions and Limits to Arbitrage
Sunday, Jan. 8, 2017 1:00 PM – 3:00 PM
Sheraton Grand Chicago, Chicago Ballroom X
- Chair: Dimitri Vayanos, London School of Economics and Political Science
The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies
AbstractWe examine the causal effect of limits to arbitrage on ten well-known asset pricing anomalies using Regulation SHO, which relaxes short-sale constraints for a random set of pilot stocks, as a natural experiment. We find that the anomalies become substantially weaker on portfolios constructed with pilot stocks during the pilot period. Regulation SHO reduces the combined anomaly long-short portfolio returns by 77 basis points per month, a difference which survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.
Slow Trading and Stock Return Predictability
AbstractThe state of market returns positively predicts the size premium (or the difference in the return on small and large firms). A trading strategy that buys (sells) small firms and sells (buys) large firms following positive (negative) market return states yields large, risk-adjusted monthly profits of 1.8%, 3.0% or 4.3% when rebalanced monthly, weekly or daily. Moreover, this predictability is also present in actively traded ETFs and in recent years. We uncover that when rebalancing portfolios, institutional investors execute trades in large-cap stocks swiftly, but are slower in trading small firms, hence contributing to the predictability of size-based stock returns.
The Supply of Liquidity and Real Economic Activity
AbstractThis paper identifies shocks to the supply of liquidity by dealer firms and investigates their effects on real economic activity. First, I develop a simple theoretical model of dealer intermediation; then, in a structural VAR model, I use sign restrictions derived from the theoretical model to identify liquidity supply shocks. Liquidity supply shocks that are orthogonal to information contained in macroeconomic and asset price variables have considerable predictive power for economic activity. Moreover, positive liquidity supply shocks cause large and persistent increases in real activity.
University of North Carolina-Chapel Hill
- G1 - Asset Markets and Pricing