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Price Impact Costs and the Limit of Arbitrage

  • Zhiwu Chen
  • Werner Stanzl
  • Masahiro Watanabe

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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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
Contact details of provider: Web page: http://icf.som.yale.edu/

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  1. Tobias J. Moskowitz & Mark Grinblatt, . "Do Industries Explain Momentum?," CRSP working papers 480, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  2. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  3. 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.
  4. Jerry A. Hausman & Andrew W. Lo & A. Craig MacKinlay, 1991. "An Ordered Probit Analysis of Transaction Stock Prices," NBER Working Papers 3888, National Bureau of Economic Research, Inc.
  5. 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.
  6. Narasimhan Jegadeesh, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, vol. 56(2), pages 699-720, 04.
  7. Dutta, P.K. & Madhavan, A., 1992. "Price Continuity Rules and Insider Trading," RCER Working Papers 338, University of Rochester - Center for Economic Research (RCER).
  8. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  9. 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.
  10. Gur Huberman & Werner Stanzl, 2000. "Optimal Liquidity Trading," Yale School of Management Working Papers ysm165, Yale School of Management, revised 01 Aug 2001.
  11. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-46, June.
  12. Keim, Donald B., 1983. "Size-related anomalies and stock return seasonality : Further empirical evidence," Journal of Financial Economics, Elsevier, vol. 12(1), pages 13-32, June.
  13. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  14. Chan, Louis K C & Lakonishok, Josef, 1995. " The Behavior of Stock Prices around Institutional Trades," Journal of Finance, American Finance Association, vol. 50(4), pages 1147-74, September.
  15. Bertsimas, Dimitris & Lo, Andrew W., 1998. "Optimal control of execution costs," Journal of Financial Markets, Elsevier, vol. 1(1), pages 1-50, April.
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