Limits of Limits of Arbitrage: Theory and Evidence

Johan Hombert and David Thesmar
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Johan Hombert: GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique

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Abstract: We present a model where arbitrageurs operate on an asset market that can be hit by information shocks. Before entering the market, arbitrageurs are allowed to optimize their capital structure, in order to take advantage of potential underpricing. We find that, at equilibrium, some arbitrageurs always receive funding, even in low information environments. Other arbitrageurs only receive funding in high information environments. The model makes two easily testable predictions: first, arbitrageurs with stable funding should experience more mean-reversion in returns, in particular following low performance. Second, this larger mean-reversion should be lower, if many other funds have stable fundings. We test these predictions on a sample of hedge funds, some of which impose impediments to withdrawal to their investors.

Keywords: Limits; Arbitrage (search for similar items in EconPapers)
Date: 2012-12-04
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Published in 2012

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Related works:
Working Paper: Limits of Limits of Arbitrage: Theory and Evidence (2009)
Working Paper: Limits of Limits of Arbitrage: Theory and Evidence (2009)
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