Overcoming limits of arbitrage: Theory and evidence

Johan Hombert and David Thesmar

Journal of Financial Economics, 2014, vol. 111, issue 1, 26-44

Abstract: Limits to arbitrage arise because financial intermediaries may face funding constraints when mispricing worsens. Using a model with limits to arbitrage, where we allow arbitrageurs to secure capital even in case of underperformance, we show that arbitrageurs that are more protected from withdrawals have more mean-reverting and volatile returns. Using data on hedge fund performance, we find robust support for these hypotheses: Funds with contractual impediments to withdrawals, and funds with performance-insensitive outflows, recover more quickly after a bad year and have more volatile returns. Our evidence is consistent with the idea that some hedge funds overcome the limits to arbitrage.

Keywords: Limits to arbitrage; Hedge funds; Capital structure (search for similar items in EconPapers)
JEL-codes: G10 G23 G32 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:111:y:2014:i:1:p:26-44

DOI: 10.1016/j.jfineco.2013.09.003

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