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Arbitrage Trading The Long and the Short of It


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Arbitrage Trading: The Long and the Short of It
Yong Chen
Texas A&M University
Zhi Da
University of Notre Dame
Dayong Huang
University of North Carolina at Greensboro
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. (JEL G11, G23)
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.
We are grateful to Andrew Karolyi (the Executive Editor) and an anonymous referee for valuable advice. We thank Charles Cao, Roger Edelen, Samuel Hanson, Johan Hombert (Paris conference discussant), Byoung- Hyoun Hwang (AFA discussant), Hagen Kim, Weikai Li (CICF discussant), Bing Liang, Jeffrey Pontiff, Marco Rossi, Kalle Rinne (Luxembourg conference discussant), Thomas Ruf (EFA discussant), Clemens Sialm, Sorin Sorescu, Zheng Sun, Robert Stambaugh, Wei Wu, Jianfeng Yu, and seminar and conference participants at McMaster University, Miami University, Texas A&M University, University of Hawaii, University of Notre Dame, the 2015 European Finance Association Meeting in Vienna, the 4th Luxembourg Asset Management Summit, 2015 Macquarie Global Quantitative Research Conference in Hong Kong, the 2016 American Finance Association Annual Meeting in San Francisco, the 8th Annual Hedge Fund Research Conference in Paris, the 2016 China International Conference in Finance in Xiamen, and the 2016 Financial Management Association Meeting in Las Vegas for helpful discussions and comments. Chen acknowledges financial support from the Republic Bank Research Fellowship at Texas A&M University. Da acknowledges financial support from the Zych Family Fellowship at the Notre Dame Institute for Global Investing. We are responsible for all remaining errors. Supplementary data can be found on The Review of Financial Studies Web site. Send correspondence to Yong Chen, Department of Finance, Mays Business School, Texas A&M University, College Station, TX 77843–4218; telephone: (979) 845–3870. E-mail: ychen@mays.tamu.edu.
© The Author(s) 2018. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oup.com.
doi:10.1093/rfs/hhy097
Downloaded from https://academic.oup.com/rfs/advance-article-abstract/doi/10.1093/rfs/hhy097/5086321 by Kresge Law Library user on 22 October 2018

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