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Arbitrage Risk and Stock Mispricing

Published online by Cambridge University Press:  17 September 2010

John A. Doukas ,
Chansog (Francis) Kim  and
Christos Pantzalis
John A. Doukas
Affiliation:
Department of Finance, School of Business and Public Administration, Old Dominion University, Norfolk, VA 23529, and Judge Business School, University of Cambridge, Cambridge CB2 1AG, UK. [email protected]
Chansog (Francis) Kim
Affiliation:
Department of Accountancy, City University of Hong Kong, Tat Chee Ave., Kowloon, Hong Kong. [email protected]
Christos Pantzalis
Affiliation:
Department of Finance, College of Business Administration, University of South Florida, 4202 E. Fowler Ave., BSN 3403, Tampa, FL 33620. [email protected]
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Abstract

In this paper we examine the relation between equity mispricing and arbitrage risk and find that stocks with high arbitrage risk have higher estimated mispricing than stocks with low arbitrage risk. These results are not limited to high book-to-market or small capitalization stocks, and they are not sensitive to transaction and short-selling costs. In addition, they remain robust to alternative multifactor return generating specification models and mispricing measures. Overall, our empirical results are consistent with the conjecture that mispricing is a manifestation of the inability of arbitrageurs to hedge idiosyncratic risk, a major deterrent to arbitrage activity.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 4 , August 2010 , pp. 907 - 934
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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