Arbitrage risk and the book-to-market anomaly

Ashiq Ali, Lee Seok Hwang, Mark A. Trombley

Research output: Contribution to journalArticle

156 Scopus citations

Abstract

This paper shows that the book-to-market (B/M) effect is greater for stocks with higher idiosyncratic return volatility, higher transaction costs, and lower investor sophistication, consistent with the market-mispricing explanation for the anomaly. The B/M effect for high volatility stocks exceeds that for the low volatility stocks in 20 of the 22 sample years. Also, volatility exhibits significant incremental power beyond transaction costs and investor sophistication measures in explaining cross-sectional variation in the B/M effect. These findings are consistent with the Shleifer and Vishny (1997) thesis that risk associated with the volatility of arbitrage returns deters arbitrage activity and is an important reason why the B/M effect exists.

Original languageEnglish (US)
Pages (from-to)355-373
Number of pages19
JournalJournal of Financial Economics
Volume69
Issue number2
DOIs
StatePublished - Aug 1 2003

Keywords

  • Arbitrage risk
  • Book-to-market
  • Investor sophistication
  • Mispricing
  • Transaction costs

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

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