Research Summary
Research Summary
Implications of Limits of Arbitrage (with James Choi)
Description
In this project we investigate the relationship between limits to arbitrage facing mutual fund managers and asset pricing anomalies. We measure changes in the limits to arbitrage by computing the average of slopes on current and past returns in quarterly flow-performance regressions. We use this average slope to predict future returns on various portfolio strategies such as value minus growth, small minus big, and momentum. The prediction is that when the slope increases these strategies, which are winners over the long run, will temporarily lose money as arbitrageurs are forced to bet less aggressively on them.