Hostname: page-component-84b7d79bbc-5lx2p Total loading time: 0 Render date: 2024-07-28T15:33:09.279Z Has data issue: false hasContentIssue false
  • English
  • Français

Capital Market Efficiency and Arbitrage Efficacy

Published online by Cambridge University Press:  10 June 2016

Ferhat Akbas ,
Will J. Armstrong ,
Sorin Sorescu  and
Avanidhar Subrahmanyam
Ferhat Akbas
Affiliation:
akbas@ku.edu, University of Kansas, School of Business, Lawrence, KS 66045
Will J. Armstrong
Affiliation:
will.armstrong@ttu.edu, Texas Tech University, Rawls College of Business, Lubbock, TX 79409
Sorin Sorescu
Affiliation:
ssorescu@tamu.edu, Texas A&M University, Mays Business School, College Station, TX 77843
Avanidhar Subrahmanyam*
Affiliation:
subra@anderson.ucla.edu, Nanjing University, School of Management and Engineering, Jiangsu Province, 210093 China, and University of California at Los Angeles, Anderson School of Management, Los Angeles, CA 90095.
*
*Corresponding author: subra@anderson.ucla.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

Efficiency in the capital markets requires that capital flows are sufficient to arbitrage anomalies away. We examine the relation between flows to a quantitative (quant) strategy that is based on capital market anomalies and the subsequent performance of this strategy. When these flows are high, quant funds are able to implement arbitrage strategies more effectively, which in turn leads to lower profitability of market anomalies in the future, and vice versa. Thus, the degree of cross-sectional equity market efficiency varies across time with the availability of arbitrage capital.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 2 , April 2016 , pp. 387 - 413
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Acharya, V. V.; Lochstoer, L. A.; and Ramadorai, T.. “Limits to Arbitrage and Hedging: Evidence from Commodity Markets.” Journal of Financial Economics, 109 (2013), 441–465.CrossRefGoogle Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Antón, M., and Polk, C.. “Connected Stocks.” Journal of Finance, 69 (2014), 1099–1127.CrossRefGoogle Scholar
Baker, M., and Savasoglu, S.. “Limited Arbitrage in Mergers and Acquisitions.” Journal of Financial Economics, 64 (2002), 91–115.CrossRefGoogle Scholar
Basu, S. “Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratio: A Test of the Efficient Market Hypothesis.” Journal of Finance, 32 (1977), 663–682.Google Scholar
Ben-Rephael, A.; Kandel, S.; and Wohl, A.. “Measuring Investor Sentiment with Mutual Fund Flows.” Journal of Financial Economics, 104 (2012), 363–382.CrossRefGoogle Scholar
Berk, J. “A Critique of Size-Related Anomalies.” Review of Financial Studies, 8 (1995), 275–286.CrossRefGoogle Scholar
Bernard, V. L., and Thomas, J. K.. “Post-Earnings-Announcement Drift: Delayed Price Response or Risk Premium?” Journal of Accounting Research, 27 (1989), 1–36.CrossRefGoogle Scholar
Chan, L. K. C.; Hamao, Y.; and Lakonishok, J.. “Fundamentals and Stock Returns in Japan.” Journal of Finance, 46 (1991), 1739–1764.CrossRefGoogle Scholar
Chevalier, J., and Ellison, G.. “Risk Taking by Mutual Funds as a Response to Incentives.” Journal of Political Economy, 105 (1997), 1167–1200.CrossRefGoogle Scholar
Coval, J., and Stafford, E.. “Asset Fire Sales (and Purchases) in Equity Markets.” Journal of Financial Economics, 86 (2007), 479–512.CrossRefGoogle Scholar
Daniel, K.; Hirshleifer, D.; and Subrahmanyam, A.. “Investor Psychology and Investor Under- and Overreactions.” Journal of Finance, 53 (1998), 1839–1885.CrossRefGoogle Scholar
Daniel, K., and Titman, S.. “Evidence on the Characteristics of Cross-Sectional Variation in Common Stock Returns.” Journal of Finance, 52 (1997), 1–33.CrossRefGoogle Scholar
Fama, E. F. “Efficient Capital Markets: A Review of Theory and Empirical Work.” Journal of Finance, 25 (1970), 383–417.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Frazzini, A., and Lamont, O. A.. “Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns.” Journal of Financial Economics, 88 (2008), 299–322.CrossRefGoogle Scholar
Gil-Bazo, J., and Ruiz-Verdú, P.. “The Relation between Price and Performance in the Mutual Fund Industry.” Journal of Finance, 64 (2009), 2153–2183.CrossRefGoogle Scholar
Graham, B., and Dodd, D. L.. Security Analysis. New York: Whittlesey House (1934).Google Scholar
Greenwood, R., and Thesmar, D.. “Stock Price Fragility.” Journal of Financial Economics, 102 (2011), 471–490.CrossRefGoogle Scholar
Gromb, D., and Vayanos, D.. “Limits of Arbitrage.” Annual Review of Financial Economics, 2 (2010), 251–275.CrossRefGoogle Scholar
Hasbrouck, J. “Trading Costs and Returns for U.S. Equities: Estimating Effective Costs from Daily Data.” Journal of Finance, 64 (2009), 1445–1477.CrossRefGoogle Scholar
He, Z., and Krishnamurthy, A.. “A Model of Capital and Crises.” Review of Economic Studies, 79 (2012), 735–777.CrossRefGoogle Scholar
He, Z., and Krishnamurthy, A.. “Intermediary Asset Pricing.” American Economic Review, 103 (2013), 732–770.CrossRefGoogle Scholar
Huang, J.; Wei, K. D.; and Yan, H.. “Participation Costs and the Sensitivity of Fund Flows to Past Performance.” Journal of Finance, 62 (2007), 1273–1311.CrossRefGoogle Scholar
Ippolito, R. A. “Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry.” Journal of Law and Economics, 35 (1992), 45–70.CrossRefGoogle Scholar
Jacoby, G.; Fowler, D. J.; and Gottesman, A.. “The Capital Asset Pricing Model and the Liquidity Effect: A Theoretical Approach.” Journal of Financial Markets, 3 (2000), 69–81.CrossRefGoogle Scholar
Jaffe, J.; Keim, D. B.; and Westerfield, R.. “Earnings Yields, Market Values and Stock Returns.” Journal of Finance, 45 (1989), 135–148.CrossRefGoogle Scholar
Jegadeesh, N. “Evidence of Predictable Behavior of Security Returns.” Journal of Finance, 45 (1990), 881–898.CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
Johnson, S. A.; Moorman, T. C.; and Sorescu, S.. “A Reexamination of Corporate Governance and Equity Prices.” Review of Financial Studies, 22 (2009), 4753–4786.CrossRefGoogle Scholar
Jones, C. M. “A Century of Stock Market Liquidity and Trading Costs.” Working Paper, Columbia University (2002).CrossRefGoogle Scholar
Jorion, P. “Risk-Management Lessons from Long-Term Capital Management.” European Financial Management, 6 (2000), 277–300.CrossRefGoogle Scholar
Jotikasthira, C.; Lundblad, C.; and Ramadorai, T.. “Asset Fire Sales and Purchases and the International Transmission of Funding Shocks.” Journal of Finance, 67 (2012), 2015–2050.CrossRefGoogle Scholar
Khan, M.; Kogan, L.; and Serafeim, G.. “Mutual Fund Trading Pressure: Firm-Level Stock Price Impact and Timing of SEOs.” Journal of Finance, 67 (2012), 1371–1395.CrossRefGoogle Scholar
Kokkonen, J., and Suominen, M.. “Hedge Funds and Stock Market Efficiency.” Management Science, 61 (2015), 2890–2904.CrossRefGoogle Scholar
Kothari, S. “Capital Market Research in Accounting.” Journal of Accounting and Economics, 31 (2001), 105–231.CrossRefGoogle Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance, 49 (1994), 1541–1578.CrossRefGoogle Scholar
Lamont, O. A., and Thaler, R. H.. “Can the Market Add and Subtract? Mispricing in Tech Stock Carve-Outs.” Journal of Political Economy, 111 (2003), 227–268.CrossRefGoogle Scholar
Lee, C. M. C. “Market Efficiency and Accounting Research: A Discussion of ‘Capital Market Research in Accounting’ by S. P. Kothari.” Journal of Accounting and Economics, 31 (2001), 233–253.CrossRefGoogle Scholar
Lou, D. “A Flow-Based Explanation for Return Predictability.” Review of Financial Studies, 25 (2012), 3457–3489.CrossRefGoogle Scholar
McLean, R. D., and Pontiff, J.. “Does Academic Research Destroy Stock Return Predictability?” Journal of Finance, 71 (2016), 5–32.CrossRefGoogle Scholar
Mitchell, M.; Pedersen, L. H.; and Pulvino, T.. “Slow Moving Capital.” American Economic Review, 97 (2007), 215–220.CrossRefGoogle Scholar
Mitchell, M.; Pulvino, T.; and Stafford, E.. “Limited Arbitrage in Equity Markets.” Journal of Finance, 57 (2002), 551–584.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Ou, J. A., and Penman, S. H.. “Financial Statement Analysis and the Prediction of Stock Returns.” Journal of Accounting and Economics, 11 (1989), 295–329.CrossRefGoogle Scholar
Pástor, L., and Stambaugh, R. F.. “On the Size of the Active Management Industry.” Journal of Political Economy, 120 (2012), 740–781.CrossRefGoogle Scholar
Piotroski, J. D. “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers.” Journal of Accounting Research, 38 (2000), 1–41.CrossRefGoogle Scholar
Pontiff, J. “Costly Arbitrage: Evidence from Closed-End Funds.” Quarterly Journal of Economics, 111 (1996), 1135–1151.CrossRefGoogle Scholar
Pontiff, J. “Costly Arbitrage and the Myth of Idiosyncratic Risk.” Journal of Accounting and Economics, 42 (2006), 35–52.CrossRefGoogle Scholar
Rosenberg, B.; Reid, K.; and Lanstein, R.. “Persuasive Evidence of Market Inefficiency.” Journal of Portfolio Management, 11 (1985), 9–16.CrossRefGoogle Scholar
Rouwenhorst, K. G. “International Momentum Strategies.” Journal of Finance, 53 (1998), 267–284.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R. W.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.CrossRefGoogle Scholar
Sirri, E. R., and Tufano, P.. “Costly Search and Mutual Fund Flows.” Journal of Finance, 53 (1998), 1589–1622.CrossRefGoogle Scholar
Sloan, R. G. “Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings?” Accounting Review, 71 (1996), 289–315.Google Scholar
Vayanos, D. “Flight to Quality, Flight to Liquidity and the Pricing of Risk.” Working Paper, London School of Economics (2004).CrossRefGoogle Scholar
Vayanos, D., and Woolley, P.. “An Institutional Theory of Momentum and Reversal.” Review of Financial Studies, 26 (2013), 1087–1145.CrossRefGoogle Scholar