Correlation Between Market Anomalies And Its Impact On The Economy

1370 Words6 Pages
Since the profits of relative strength strategies have been considered to be behavioral phenomena and arbitrage is the last and the strongest defender of market efficiency, it is possible to be dubious that limit to arbitrage leads to abnormal returns generated by momentum strategies. This paper fill the gap in literature because of two reasons : firstly, as original purpose, it provides a view on relative strength profitability ; secondly , I do not see many papers looking at relationship between market anomalies although momentum profits and limit to arbitrage have been strongly debated among studies.
Barberis and Thaler (2003) presented 3 possible obstacles prevent arbitrageurs from taking advantages of stock mispricing. They argued that arbitrage is limited because of fundamental risk, noise traders risk and implementation costs. Fundamental risk in the sense that perfect substitutes are rare in the real world and arbitrageurs cannot eliminate fundamental risk related to stocks shorted. For example, when arbitrageurs short Ford stocks and buy GM stocks, they can only eliminate risk related to car industry as a whole but cannot avoid the risk specific to Ford. Even there are perfect substitutes, the risk that pessimistic traders driving down stock price more is possible in short run and this forces arbitrageurs close their positions leading to bigger loss. According to Shleifer and Visny (1997) , this situation is highly possible. Shleifer and Visny (1997) argued
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