Price Impact Costs and the Limit of Arbitrage

Zhiwu Chen, Werner Stanzl and Masahiro Watanabe

Yale School of Management Working Papers from Yale School of Management

Abstract: This paper investigates whether one can profit from the size, book-to-market, or momentum anomaly, when price-impact costs are taken into account. A non-linear price-impact function is individually estimated for 5173 stocks to assess the magnitude of trading costs. Compared to constant proportional transaction costs (as typically assumed in the literature), a concave price-impact function tends to assign a higher impact cost to mid-size trades and a lower impact to large-size trades. We implement long-short arbitrage strategies based on each such anomaly, and estimate the maximal fund size possible before excess returns become negative. For all anomalies, the maximal fund sizes are small in order to remain profitable. Markets are therefore bounded-rational: price-impact costs deter agents from exploiting the anomalies.

Keywords: Stock market anomaly; Price-impact function; Arbitrage; Fund size limit (search for similar items in EconPapers)
JEL-codes: G1 (search for similar items in EconPapers)
Date: 2002-07-10, Revised 2006-06-08
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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