Ubid

In: Business and Management

Submitted By ajkdshfslkdhf
Words 992
Pages 4
Limited Arbitrage in Equity Markets
MARK MITCHELL, TODD PULVINO, and ERIK STAFFORD*
ABSTRACT
We examine 82 situations where the market value of a company is less than its subsidiary. These situations imply arbitrage opportunities, providing an ideal setting to study the risks and market frictions that prevent arbitrageurs from immediately forcing prices to fundamental values. For 30 percent of the sample, the link between the parent and its subsidiary is severed before the relative value discrepancy is corrected. Furthermore, returns to a specialized arbitrageur would be 50 percent larger if the path to convergence was smooth rather than as observed.
Uncertainty about the distribution of returns and characteristics of the risks limits arbitrage. THIS PAPER EXAMINES IMPEDIMENTS to arbitrage in equity markets using a sample of 82 situations between 1985 and 2000, where the market value of a company is less than that of its ownership stake in a publicly traded subsidiary.
These situations suggest clear arbitrage opportunities, yet, they often persist, and therefore provide an interesting setting in which to study the risks and market frictions that prevent arbitrageurs from quickly forcing prices to fundamental values.
Arbitrage is one of the central tenets of financial economics, enforcing the law of one price and keeping markets efficient. In its purest form, arbitrage requires no capital and is risk free ~see Dybvig and Ross ~1992!!. By simultaneously selling and purchasing identical securities at favorably different prices, the arbitrageur captures an immediate payoff with no up-front capital.
Of course, pure arbitrage exists only in perfect capital markets. In the real world, imperfect information and market frictions make what is referred to as “arbitrage” both capital intensive and risky.
Imperfect information and market frictions can…...

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