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Arbitrage Trading: The Long and the Short of It

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  • Yong Chen
  • Zhi Da
  • Dayong Huang

Abstract

We examine net arbitrage trading (NAT) measured by the difference between quarterly abnormal hedge fund holdings and abnormal short interest. NAT strongly predicts stock returns in the cross-section. Across ten well-known stock anomalies, abnormal returns are realized only among stocks experiencing large NAT. Exploiting Regulation SHO, which facilitated short selling for a random group of stocks, we present causal evidence that NAT has stronger return predictability among stocks facing greater limits to arbitrage. We also find large returns for anomalies that arbitrageurs chose to exploit despite capital constraints during the 2007–09 financial crisis. We confirm our findings using daily data.Received September 1, 2016; editorial decision May 28, 2018 by Editor Andrew Karolyi. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • Yong Chen & Zhi Da & Dayong Huang, 2019. "Arbitrage Trading: The Long and the Short of It," The Review of Financial Studies, Society for Financial Studies, vol. 32(4), pages 1608-1646.
    • Handle: RePEc:oup:rfinst:v:32:y:2019:i:4:p:1608-1646.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhy097
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