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Fast and Slow Arbitrage: The Predictive Power of (Persistent) Capital Flows for Factor Returns

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  • Xi Dong
  • Namho Kang
  • Joel Peress

Abstract

We document that persistent aggregate capital flows to hedge and mutual funds predict monthly factor returns with an out-of-sample R2 reaching 6.6%. Transient flows display no such power despite being more predictable. We show—both empirically and theoretically—that persistent flows’ predictive power stems from active fund managers’ capital constraints. As a result, managers invest persistent, but not transient, capital flows into factor trading strategies, leading to factor-return predictability and factor momentum, yet greater price efficiency. Our key insight is that capital-constrained managers account for both current and anticipated future flows in the arbitrage sector, thereby incorporating the dynamics of capital into their strategies.

Suggested Citation

  • Xi Dong & Namho Kang & Joel Peress, 2025. "Fast and Slow Arbitrage: The Predictive Power of (Persistent) Capital Flows for Factor Returns," The Review of Financial Studies, Society for Financial Studies, vol. 38(10), pages 2936-2987.
    • Handle: RePEc:oup:rfinst:v:38:y:2025:i:10:p:2936-2987.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaf036
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