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  • 2014
  • Article
  • Review of Financial Studies

The Growth and Limits of Arbitrage: Evidence from Short Interest

By: Samuel G. Hanson and Adi Sunderam
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Abstract

We develop a novel methodology to infer the amount of capital allocated to quantitative equity arbitrage strategies. Using this methodology, which exploits time-variation in the cross section of short interest, we document that the amount of capital devoted to value and momentum strategies has grown significantly since the late 1980s. We provide evidence that this increase in capital has resulted in lower strategy returns. However, consistent with theories of limited arbitrage, we show that strategy-level capital flows are influenced by past strategy returns as well as strategy return volatility, and that arbitrage capital is most limited during times when strategies perform best. This suggests that the growth of arbitrage capital may not completely eliminate returns to these strategies.

Keywords

Strategy; Financial Instruments; Capital Markets; Investment

Citation

Hanson, Samuel G., and Adi Sunderam. "The Growth and Limits of Arbitrage: Evidence from Short Interest." Review of Financial Studies 27, no. 4 (April 2014): 1238–1286. (Winner of the RFS Rising Scholar Prize 2014. Internet Appendix Here.)
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About The Authors

Samuel G. Hanson

Finance
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Adi Sunderam

Finance
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More from the Authors
  • The Cross Section of Bank Value By: Mark Egan, Stefan Lewellen and Adi Sunderam
  • Predictable Financial Crises By: Robin Greenwood, Samuel G. Hanson, Andrei Shleifer and Jakob Ahm Sørensen
  • The Impact Developers Fund By: Malcolm Baker, Samuel Gregory Hanson, Jonathan Wallen and Zach Komes
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