Generalized Stochastic Arbitrage Opportunities

Stelios Arvanitis () and Thierry Post ()
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Stelios Arvanitis: Department of Economics, Athens University of Economics and Business, 10434 Athens, Greece
Thierry Post: Graduate School of Business, Nazarbayev University, Astana 010000, Kazakhstan

Management Science, 2024, vol. 70, issue 7, 4629-4648

Abstract: Concepts are introduced and applied for analyzing and selecting arbitrage portfolios in the face of uncertainty about initial positions and risk preferences. A stochastic arbitrage opportunity is defined as a zero-cost investment portfolio that enhances every feasible host portfolio for all admissible utility functions. The alternative to the existence of such investment opportunities is the existence of a solution to a dual system of asset pricing restrictions based on a class of stochastic discount factors. Feasible approaches to numerical optimization and statistical inference are discussed. Empirical results suggest that equity factor investing is appealing for all risk-averse stock investors with a wide range of initial position and sufficiently low transactions costs by mixing multiple factor portfolios with high after-cost appraisal ratios, low mutual correlation, and negative exposures to the relevant host portfolios. These findings weaken the case for risk-based explanations for the profitability of factor investing.

Keywords: portfolio analysis; arbitrage portfolios; asset pricing; incomplete markets; factor investing (search for similar items in EconPapers)
Date: 2024
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