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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…show more content…
* Mitchell and Stafford are at Harvard University, and Pulvino is at Northwestern University. We thank Brad Cornell, Kent Daniel, Mihir Desai, Rick Green, Ravi Jagannathan, Owen Lamont, André Perold, Mitch Petersen, Julio Rotemberg, Rick Ruback, Tuomo Vuolteenaho, an anonymous referee, and seminar participants at the Federal Reserve Bank of New York, Harvard Business School, Ohio State University, U.S. Securities and Exchange Commission, and the 2001 Spring NBER Asset Pricing Program Meetings for helpful comments. We also thank Asma Qureshi for research assistance, Ameritrade Holding Corporation for short-rebate data, and especially Ken French for insightful comments and discussions. Harvard Business School’s Division of Research provided research support. THE JOURNAL OF FINANCE • VOL. LVII, NO. 2 • APRIL 2002 551 Uncertainty over the distribution of arbitrage returns, especially over the mean, will deter arbitrage activity until would-be arbitrageurs learn enough about the distribution to determine that the expected payoff is large enough to cover the fixed costs of setting up shop. Even with active arbitrageurs, opportunities may persist while arbitrageurs learn how to best exploit them. Second, once the fixed costs of

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