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Systematic limited arbitrage and the cross-section of stock returns: Evidence from exchange traded funds

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  • DeLisle, R. Jared
  • McTier, Brian C.
  • Smedema, Adam R.

Abstract

We propose a parsimonious, comprehensive proxy for innovations in limited arbitrage: innovations in ETFs’ premium. Consistent with a common component, we confirm limited arbitrage factors, LAFs, constructed from ETFs’ premium innovations spanning four asset classes are correlated. Further, we find that equity LAFs are negatively priced in the cross-section of stock returns. Our pricing tests also confirm that LAFs provide pricing information beyond well-known limits of arbitrage: illiquidity and idiosyncratic volatility. Overall, our findings suggest that limited arbitrage risk is priced and LAF is a relevant risk-factor.

Suggested Citation

  • DeLisle, R. Jared & McTier, Brian C. & Smedema, Adam R., 2016. "Systematic limited arbitrage and the cross-section of stock returns: Evidence from exchange traded funds," Journal of Banking & Finance, Elsevier, vol. 70(C), pages 118-136.
    • Handle: RePEc:eee:jbfina:v:70:y:2016:i:c:p:118-136
    DOI: 10.1016/j.jbankfin.2016.06.006
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    2. Liyun Zhou & Chunpeng Yang, 2020. "Investor sentiment, investor crowded-trade behavior, and limited arbitrage in the cross section of stock returns," Empirical Economics, Springer, vol. 59(1), pages 437-460, July.

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    More about this item

    Keywords

    Asset pricing; Factor model; Limits of arbitrage; Systematic; Risk; Arbitrage risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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