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Costly Arbitrage And Idiosyncratic Risk
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Book Synopsis Costly Arbitrage and Idiosyncratic Risk by : Ying Duan
Download or read book Costly Arbitrage and Idiosyncratic Risk written by Ying Duan and published by . This book was released on 2013 with total page 31 pages. Available in PDF, EPUB and Kindle. Book excerpt: Previous studies have shown that high short interest stocks have low subsequent returns. We test whether the persistence of this effect is due to costs limiting arbitrage. The arbitrage cost that we focus on is idiosyncratic risk which, regardless of the arbitrageur's level of diversification, deters arbitrage activity. Consistent with costly arbitrage, we find that among high short interest stocks a one standard deviation increase in idiosyncratic risk predicts a more than 1% decline in monthly returns. Moreover, idiosyncratic risk does not predict returns across low short interest stocks, and short interest does not predict low returns across low idiosyncratic risk stocks. Our results are robust to commonly used proxies for both transaction costs and short sale constraints.
Book Synopsis Costly Arbitrage and the Myth of Idiosyncratic Risk by : Jeffrey Pontiff
Download or read book Costly Arbitrage and the Myth of Idiosyncratic Risk written by Jeffrey Pontiff and published by . This book was released on 2006 with total page 35 pages. Available in PDF, EPUB and Kindle. Book excerpt: Transaction and holding costs make arbitrage costly. If some traders are rational, mispricing will only exist to the extent that arbitrage costs prevent rational traders from fully eliminating inefficiencies. Although the relation between mispricing and transaction costs is well-known, the relation between mispricing and holding costs is misunderstood. One holding cost, idiosyncratic risk, is particularly misunderstood. Various myths are debunked, including the common myth that arbitrageurs care about idiosyncratic risk because they are undiversified [Shleifer and Vishny (1997)]. The literature demonstrates that idiosyncratic risk is the single largest cost faced by arbitrageurs.
Book Synopsis Idiosyncratic Risk, Costly Arbitrage, and the Cross-Section of Stock Returns by : Jie Cao
Download or read book Idiosyncratic Risk, Costly Arbitrage, and the Cross-Section of Stock Returns written by Jie Cao and published by . This book was released on 2016 with total page 42 pages. Available in PDF, EPUB and Kindle. Book excerpt: We test a new cross-sectional relation between expected stock return and idiosyncratic risk implied by the theory of costly arbitrage. If arbitrageurs find it more difficult to correct the mispricing of stocks with high idiosyncratic risk, there should be a positive (negative) relation between expected return and idiosyncratic risk for undervalued (overvalued) stocks. We combine several well-known anomalies to measure stock mispricing and proxy stock idiosyncratic risk using an exponential GARCH model for stock returns. We confirm that average stock returns monotonically increase (decrease) with idiosyncratic risk for undervalued (overvalued) stocks. Overall, our results support the importance of idiosyncratic risk as an arbitrage cost.
Book Synopsis Divergence of Opinion, Arbitrage Costs and Stock Returns by : Jin (Ginger) Wu
Download or read book Divergence of Opinion, Arbitrage Costs and Stock Returns written by Jin (Ginger) Wu and published by . This book was released on 2008 with total page 38 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper we examine how divergence of opinion affect cross-sectional asset returns for different stocks with different arbitrage costs by employing a new proxy for divergence of opinion. We generalize Tauchen and Pitts' (1983) well-known Mixture of Distribution Hypothesis (MDH), which links asset volume and volatility in a way that derives a proxy for divergence of opinion among all individual investors. This new measure is a more reliable proxy for divergence of opinion among all individual investors than the existing proxies such as dispersion in analysts' earnings forecasts and turnover. We then use this measure of divergence of opinion in an empirical asset pricing analysis. In particular, we incorporate the crucial role of divergence of opinion in the determination of cross-sectional asset returns, establishing that when divergence of opinion is high, stock prices tend to be biased upwardly, resulting in lower future returns. These effects are especially pronounced for stocks with higher arbitrage costs including idiosyncratic risks, short sale costs, and other transaction costs, which are more difficult and costly to short sell. Hence the evidence for these stocks support Miller's (1977) view that, given short-sale constraints, observed prices overweight optimistic valuations. The predictions of recent theoretical work, such as Hong and Stein (2003), are valid only for stocks with less arbitrage costs. Also, our results suggest that the idiosyncratic risk, relative to other arbitrage cost measure, incrementally explain the divergence of opinon's effect on stock returns.
Book Synopsis Idiosyncratic Risk, Long-Term Reversal, and Momentum by : R. David McLean
Download or read book Idiosyncratic Risk, Long-Term Reversal, and Momentum written by R. David McLean and published by . This book was released on 2009 with total page 44 pages. Available in PDF, EPUB and Kindle. Book excerpt: I test whether the persistence of the momentum and reversal effects is the result of idiosyncratic risk limiting arbitrage. Idiosyncratic deters arbitrage, regardless of the arbitrageur's level of diversification. Reversal is prevalent only in high idiosyncratic risk stocks, suggesting that idiosyncratic risk limits arbitrage in reversal mispricing. This finding is robust to controls for transaction costs, informed trading, and systematic relations between idiosyncratic risk and subsequent returns. Momentum is not related to idiosyncratic risk. Momentum generates a smaller aggregate return than reversal, so the findings along with those in related studies suggest that transaction costs are sufficient to prevent arbitrageurs from eliminating momentum mispricing.
Download or read book Arbitrage written by Michael G. Allingham and published by Springer. This book was released on 1991-07-01 with total page 175 pages. Available in PDF, EPUB and Kindle. Book excerpt: A text using the concept of arbitrage to value securities, that is to construct the elements of financial economics. Divided into three parts, the book develops the foundations for the study, applies the basic theorem in a single-period setting and extends the discussion to a many-period setting.
Book Synopsis Daily Short Interest, Idiosyncratic Risk, and Stock Returns by : Andrea S. Au
Download or read book Daily Short Interest, Idiosyncratic Risk, and Stock Returns written by Andrea S. Au and published by . This book was released on 2009 with total page 46 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper examines the relation between short selling and returns and the impact of arbitrage costs on short sellers' behavior. Using daily UK short selling data, we find that stocks with low short interest levels experience significant positive returns on both an equal- and value-weighted basis. Economic theory predicts that short sellers avoid establishing positions in stocks with high idiosyncratic risk. Our results indicate a negative relation between short interest and returns among high idiosyncratic risk stocks and that short selling activity is mostly concentrated in low idiosyncratic risk stocks where it is less costly to arbitrage fundamental risk.
Book Synopsis Asymmetric Asset Price Reaction to News and Arbitrage Risk by : John A. Doukas
Download or read book Asymmetric Asset Price Reaction to News and Arbitrage Risk written by John A. Doukas and published by . This book was released on 2009 with total page 35 pages. Available in PDF, EPUB and Kindle. Book excerpt: This study documents that high book-to-market (value) and low book-to-market (glamour) stock prices react asymmetrically to both common and firm-specific information. Specifically, we find that value stock prices exhibit a considerably slow adjustment to both common and firm-specific information relative to glamour stocks. The results show that this pattern of differential price adjustment between value and glamour stocks is mainly driven by the high arbitrage risk borne by value stocks. The evidence is consistent with the arbitrage risk hypothesis of Shleifer and Vishny (1997), predicting that idiosyncratic risk, a major impediment to arbitrage activity, amplifies the informational loss of value stocks as a result of arbitrageurs' (informed investors) reduced participation in value stocks because of their inability to fully hedge idiosyncratic risk.
Book Synopsis Two Essays on Market Efficiency. Tests of Idiosyncratic Risk: Informed Trading Versus Noise and Arbitrage Risk, And, Agency Costs and the Underlying Causes of Mispricing: Information Asymmetry Versus Conflict of Interests by : Jung Chul Park
Download or read book Two Essays on Market Efficiency. Tests of Idiosyncratic Risk: Informed Trading Versus Noise and Arbitrage Risk, And, Agency Costs and the Underlying Causes of Mispricing: Information Asymmetry Versus Conflict of Interests written by Jung Chul Park and published by . This book was released on 2007 with total page 107 pages. Available in PDF, EPUB and Kindle. Book excerpt: I examine the informational efficiency of stock markets by testing the relation between idiosyncratic volatility and equity mispricing. I find that the level of mispricing declines with idiosyncratic volatility consistent with the notion that greater levels of firm-specific risk reflect greater participation of informed traders in the market for the stock. However, I also find that mispricing increases with idiosyncratic volatility for highly volatile stocks, and this is attributed to both noise trading and arbitrage risk. In addition, I investigate the link between agency costs and equity mispricing, and whether it exists due to information asymmetry or the degree of conflict of interests between managers and shareholders. I provide evidence that the level of agency costs is positively related with mispricing. In contrast to previous studies' claim that the information asymmetry level is a key determinant in the equity mispricing, I find that the conflict of interests is more important than information asymmetry in explaining equity mispricing. Furthermore, the evidence suggests that stock option grants, originally intended to resolve conflicts of interests, actually exaggerate this problem.
Book Synopsis Two Essays on the Impact of Idiosyncratic Risk on Asset Returns by : Jie Cao
Download or read book Two Essays on the Impact of Idiosyncratic Risk on Asset Returns written by Jie Cao and published by . This book was released on 2009 with total page 232 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this dissertation, I explore the impact of idiosyncratic risk on asset returns. The first essay examines how idiosyncratic risk affects the cross-section of stock returns. I use an exponential GARCH model to forecast expected idiosyncratic volatility and employ a combination of the size effect, value premium, return momentum and short-term reversal to measure relative mispricing. I find that stock returns monotonically increase in idiosyncratic risk for relatively undervalued stocks and monotonically decrease in idiosyncratic risk for relatively overvalued stocks. This phenomenon is robust to various subsamples and industries, and cannot be explained by risk factors or firm characteristics. Further, transaction costs, short-sale constraints and information uncertainty cannot account for the role of idiosyncratic risk. Overall, these findings are consistent with the limits of arbitrage arguments and demonstrate the importance of idiosyncratic risk as an arbitrage cost. The second essay studies the cross-sectional determinants of delta-hedged stock option returns with an emphasis on the pricing of volatility risk. We find that the average delta-hedged option returns are significantly negative for most stocks, and they decrease monotonically with both total and idiosyncratic volatility of the underlying stock. Our results are robust and cannot be explained by the Fama-French factors, market volatility risk, jump risk, or the effect of past stock return and volatility-related option mispricing. Our results strongly support a negative market price of volatility risk specification that is proportional to the volatility level. Reflecting this volatility risk premium, writing covered calls on high volatility stocks on average earns about 2% more per month than selling covered calls on low volatility stocks. This spread is higher when it is more difficult to arbitrage between stock and option.
Book Synopsis Inefficient Markets by : Andrei Shleifer
Download or read book Inefficient Markets written by Andrei Shleifer and published by OUP Oxford. This book was released on 2000-03-09 with total page 225 pages. Available in PDF, EPUB and Kindle. Book excerpt: The efficient markets hypothesis has been the central proposition in finance for nearly thirty years. It states that securities prices in financial markets must equal fundamental values, either because all investors are rational or because arbitrage eliminates pricing anomalies. This book describes an alternative approach to the study of financial markets: behavioral finance. This approach starts with an observation that the assumptions of investor rationality and perfect arbitrage are overwhelmingly contradicted by both psychological and institutional evidence. In actual financial markets, less than fully rational investors trade against arbitrageurs whose resources are limited by risk aversion, short horizons, and agency problems. The book presents and empirically evaluates models of such inefficient markets. Behavioral finance models both explain the available financial data better than does the efficient markets hypothesis and generate new empirical predictions. These models can account for such anomalies as the superior performance of value stocks, the closed end fund puzzle, the high returns on stocks included in market indices, the persistence of stock price bubbles, and even the collapse of several well-known hedge funds in 1998. By summarizing and expanding the research in behavioral finance, the book builds a new theoretical and empirical foundation for the economic analysis of real-world markets.
Book Synopsis Investor Sentiment, Limited Arbitrage and the Cash Holding Effects by : Xiafei Li
Download or read book Investor Sentiment, Limited Arbitrage and the Cash Holding Effects written by Xiafei Li and published by . This book was released on 2016 with total page 41 pages. Available in PDF, EPUB and Kindle. Book excerpt: We examine the market mispricing and limits-to-arbitrage hypotheses on the positive relation between cash holdings and expected stock returns. Using investor sentiment as a proxy for market mispricing, we find that returns of cash holding stocks are heavily influenced by investor sentiment. Using transaction costs, institutional ownership and idiosyncratic volatility as proxies for limits-to-arbitrage, we show that the cash holding effects are strong among stocks with large transaction and short selling costs, and high idiosyncratic volatility. This indicates that high arbitrage costs and risks prevent arbitrageurs to eliminate the mispricing on the cash holding effects.
Book Synopsis The Limits to Arbitrage Revisited by : Li, Xi
Download or read book The Limits to Arbitrage Revisited written by Li, Xi and published by . This book was released on 2014 with total page 34 pages. Available in PDF, EPUB and Kindle. Book excerpt: Using idiosyncratic volatility as a proxy for arbitrage costs, the authors found that the highly publicized accrual and asset growth anomalies exist because of high barriers to arbitrage, occurring predominantly in the universe of stocks with higher arbitrage risks. Therefore, investors who seek to profit from the accrual and asset growth anomalies must bear greater uncertainty in outcomes than was previously understood.
Book Synopsis Price-Based Investment Strategies by : Adam Zaremba
Download or read book Price-Based Investment Strategies written by Adam Zaremba and published by Springer. This book was released on 2018-07-25 with total page 325 pages. Available in PDF, EPUB and Kindle. Book excerpt: This compelling book examines the price-based revolution in investing, showing how research over recent decades has reinvented technical analysis. The authors discuss the major groups of price-based strategies, considering their theoretical motivation, individual and combined implementation, and back-tested results when applied to investment across country stock markets. Containing a comprehensive sample of performance data, taken from 24 major developed markets around the world and ranging over the last 25 years, the authors construct practical portfolios and display their performance—ensuring the book is not only academically rigorous, but practically applicable too. This is a highly useful volume that will be of relevance to researchers and students working in the field of price-based investing, as well as individual investors, fund pickers, market analysts, fund managers, pension fund consultants, hedge fund portfolio managers, endowment chief investment officers, futures traders, and family office investors.
Book Synopsis Arbitrage Risk and Stock Mispricing by : John A. Doukas
Download or read book Arbitrage Risk and Stock Mispricing written by John A. Doukas and published by . This book was released on 2008 with total page 37 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper we examine the relation between equity mispricing and arbitrage risk, and find that stocks with high arbitrage risk have higher estimated mispricing than stocks with low arbitrage risk. These results are not limited to high book-to-market or small capitalization stocks, and they are not sensitive to transaction and short selling costs. In addition, they remain robust to alternative multifactor return generating specification models and mispricing measures. Overall, our empirical results are consistent with the conjecture that mispricing manifests the inability of arbitrageurs to hedge idiosyncratic risk, a major deterrent to arbitrage activity.
Book Synopsis Arbitrage Risk and the Book-to-Market Anomaly by : Ashiq Ali
Download or read book Arbitrage Risk and the Book-to-Market Anomaly written by Ashiq Ali and published by . This book was released on 2002 with total page 31 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper shows that the book-to-market (B/M) effect is greater for stocks with higher idiosyncratic return volatility, higher transaction costs and lower investor sophistication, consistent with the market mispricing explanation for the anomaly. The B/M effect for high volatility stocks exceeds that for the low volatility stocks in 20 of the 22 sample years. Also, volatility exhibits significant incremental power beyond the transaction costs and investor sophistication measures in explaining cross-sectional variation in the B/M effect. These findings are consistent with the Shleifer and Vishny (1997) thesis that risk associated with the volatility of arbitrage returns deters arbitrage activity and is an important reason why the B/M effect exists.
Book Synopsis Market Volatility by : Robert J. Shiller
Download or read book Market Volatility written by Robert J. Shiller and published by MIT Press. This book was released on 1992-01-30 with total page 486 pages. Available in PDF, EPUB and Kindle. Book excerpt: Market Volatility proposes an innovative theory, backed by substantial statistical evidence, on the causes of price fluctuations in speculative markets. It challenges the standard efficient markets model for explaining asset prices by emphasizing the significant role that popular opinion or psychology can play in price volatility. Why does the stock market crash from time to time? Why does real estate go in and out of booms? Why do long term borrowing rates suddenly make surprising shifts? Market Volatility represents a culmination of Shiller's research on these questions over the last dozen years. It contains reprints of major papers with new interpretive material for those unfamiliar with the issues, new papers, new surveys of relevant literature, responses to critics, data sets, and reframing of basic conclusions. Included is work authored jointly with John Y. Campbell, Karl E. Case, Sanford J. Grossman, and Jeremy J. Siegel. Market Volatility sets out basic issues relevant to all markets in which prices make movements for speculative reasons and offers detailed analyses of the stock market, the bond market, and the real estate market. It pursues the relations of these speculative prices and extends the analysis of speculative markets to macroeconomic activity in general. In studies of the October 1987 stock market crash and boom and post-boom housing markets, Market Volatility reports on research directly aimed at collecting information about popular models and interpreting the consequences of belief in those models. Shiller asserts that popular models cause people to react incorrectly to economic data and believes that changing popular models themselves contribute significantly to price movements bearing no relation to fundamental shocks.
