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Price Impact Costs and the Limit of Arbitrage

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  • Zhiwu Chen
  • Werner Stanzl
  • Masahiro Watanabe

Abstract

This paper investigates whether one can profit from the size, book-to-market, or momentum anomaly, when price-impact costs are taken into account. A non-linear price-impact function is individually estimated for 5173 stocks to assess the magnitude of trading costs. Compared to constant proportional transaction costs (as typically assumed in the literature), a concave price-impact function tends to assign a higher impact cost to mid-size trades and a lower impact to large-size trades. We implement long-short arbitrage strategies based on each such anomaly, and estimate the maximal fund size possible before excess returns become negative. For all anomalies, the maximal fund sizes are small in order to remain profitable. Markets are therefore bounded-rational: price-impact costs deter agents from exploiting the anomalies.

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File URL: http://icfpub.som.yale.edu/publications/2529
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Bibliographic Info

Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm251.

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Date of creation: 10 Jul 2002
Date of revision: 08 Jun 2006
Handle: RePEc:ysm:somwrk:ysm251

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Web page: http://icf.som.yale.edu/
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Related research

Keywords: Stock market anomaly; Price-impact function; Arbitrage; Fund size limit;

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  1. Hausman, Jerry A. & Lo, Andrew W. & MacKinlay, A. Craig, 1992. "An ordered probit analysis of transaction stock prices," Journal of Financial Economics, Elsevier, vol. 31(3), pages 319-379, June.
  2. Tobias J. Moskowitz & Mark Grinblatt, . "Do Industries Explain Momentum?," CRSP working papers 352, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  5. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
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  7. Robert A. Levy, 1967. "Relative Strength As A Criterion For Investment Selection," Journal of Finance, American Finance Association, vol. 22(4), pages 595-610, December.
  8. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March.
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  10. Bertsimas, Dimitris & Lo, Andrew W., 1998. "Optimal control of execution costs," Journal of Financial Markets, Elsevier, vol. 1(1), pages 1-50, April.
  11. repec:att:wimass:9427 is not listed on IDEAS
  12. Dutta, P.K. & Madhavan, A., 1992. "Price Continuity Rules and Insider Trading," RCER Working Papers 338, University of Rochester - Center for Economic Research (RCER).
  13. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
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Cited by:
  1. U. ´┐Żetin & R. Jarrow & P. Protter & M. Warachka, 2006. "Pricing Options in an Extended Black Scholes Economy with Illiquidity: Theory and Empirical Evidence," Review of Financial Studies, Society for Financial Studies, vol. 19(2), pages 493-529.
  2. Markus K. Brunnermeier & Lasse Heje Pederson, 2003. "Predatory trading," LSE Research Online Documents on Economics 24829, London School of Economics and Political Science, LSE Library.
  3. Antonios Siganos, 2010. "Can small investors exploit the momentum effect?," Financial Markets and Portfolio Management, Springer, vol. 24(2), pages 171-192, June.

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