The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies
Yongqiang Chu, David Hirshleifer, and Liang Ma
We examine the causal effect of limits to arbitrage on ten well-known asset pricing anomalies using Regulation SHO, which reduced the cost of short selling for a random set of pilot stocks, as a natural experiment. We find that the anomalies become substantially weaker on portfolios constructed with pilot stocks during the pilot period. Regulation SHO reduces the combined anomaly long-short portfolio returns by 77 basis points per month, a difference which survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.