The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies

Yongqiang Chu, David Hirshleifer, and Liang Ma

December 2017


We examine the causal effect of limits to arbitrage on 11 well-known asset pricing anomalies using Regulation SHO, which relaxed short-sale constraints for a random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios constructed with pilot stocks during the pilot period. Regulation SHO reduced the combined anomaly long-short portfolio returns by 72 basis points per month, a difference that survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.

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