The Limits of Arbitrage.¶
Shleifer, A., & Vishny, R. W. (1997). The Limits of Arbitrage. Journal of Finance, 52(1), 35-55.
Cited by¶
6 citations across 5 artifacts.
Each citation links to the sentence it supports in the citing article.
Primes¶
- Arbitrage (Finance)
- Modern arbitrage firms use leverage extensively, but leverage requires stable funding (repo lines, credit facilities), which became scarce during the 2008 crisis and COVID-2020 volatility, causing forced liquidations of otherwise profitable arbitrage positions—the canonical "limits of arbitrage" mechanism Shleifer and Vishny (1997) model, in which performance-based capital withdrawals force specialized arbitrageurs to unwind precisely when mispricings are largest, breaking the textbook assumption of unlimited arbitrage capacity.
This sourceModels specialized arbitrageurs running other people's capital whose performance-based funds can be withdrawn precisely when mispricings widen; this 'performance-based arbitrage' mechanism breaks the textbook assumption of unlimited arbitrage capacity and explains why mispricings can persist or grow under stress.
- Modern arbitrage firms use leverage extensively, but leverage requires stable funding (repo lines, credit facilities), which became scarce during the 2008 crisis and COVID-2020 volatility, causing forced liquidations of otherwise profitable arbitrage positions—the canonical "limits of arbitrage" mechanism Shleifer and Vishny (1997) model, in which performance-based capital withdrawals force specialized arbitrageurs to unwind precisely when mispricings are largest, breaking the textbook assumption of unlimited arbitrage capacity.
- Arbitrage (Generalized)
- Modern finance recognizes this is aspirational; as Shleifer and Vishny (1997) emphasize in their "limits of arbitrage" framework, real arbitrage carries execution risk, funding risk, model risk, and volatility risk, and capital constraints on arbitrageurs can keep mispricings open even when they are well understood.
This sourceModels specialized arbitrageurs whose performance-based capital can be withdrawn precisely when mispricings widen; this "performance-based arbitrage" mechanism breaks the textbook assumption of unlimited arbitrage capacity and explains why mispricings can persist or grow under stress.
- Modern finance recognizes this is aspirational; as Shleifer and Vishny (1997) emphasize in their "limits of arbitrage" framework, real arbitrage carries execution risk, funding risk, model risk, and volatility risk, and capital constraints on arbitrageurs can keep mispricings open even when they are well understood.
- Efficient Market Hypothesis (EMH)
- Keynesian Beauty Contest
- The line the two failures draw is worth more than the levers they cost: on this evidence a public signal shortens the recursion when it is scored against a realized outcome, and lengthens it when it merely reports what others chose.
This sourceHorizon: Shleifer, Andrei, and Robert W. Vishny. "The Limits of Arbitrage." The Journal of Finance 52, no. 1 (1997): 35–55 — "the ratio of reward to risk over shorter horizons may be more relevant." Outcome-scored price: Wolfers, Justin, and Eric Zitzewitz. "Prediction Markets." Journal of Economic Perspectives 18, no. 2 (2004): 107–126 — "the market price will be the best predictor of the event." Blinded assessment: Goldin, Claudia, and Cecilia Rouse. "Orchestrating Impartiality: The Impact of 'Blind' Auditions on Female Musicians." American Economic Review 90, no. 4 (2000): 715–741 — "the screen increases the probability a woman will be advanced and hired." Contradicts the share-counts lever: Salganik, Matthew J., Peter Sheridan Dodds, and Duncan J. Watts. "Experimental Study of Inequality and Unpredictability in an Artificial Cultural Market." Science 311, no. 5762 (2006): 854–856 — "Increasing the strength of social influence increased both inequality and unpredictability of success." Contradicts the runoff lever: Bouton, Laurent, and Gabriele Gratton. "Majority runoff elections: strategic voting and Duverger's hypothesis." Theoretical Economics 10, no. 2 (2015): 283–314 — "there are always equilibria in which only two candidates receive votes." The two dropped levers from the original list — long-horizon performance fees and transparent polling — have no source and are not restated.
- If the analyst shorts on fundamentals while the crowd keeps bidding, the position bleeds and the analyst may be fired before fundamentals reassert ("the market can stay irrational longer than you can stay solvent").
This sourceFormalizes why arbitrageurs constrained by short horizons and others' beliefs cannot bet against mispricing without risk of being forced out before fundamentals reassert ('the market can stay irrational longer than you can stay solvent').
- The line the two failures draw is worth more than the levers they cost: on this evidence a public signal shortens the recursion when it is scored against a realized outcome, and lengthens it when it merely reports what others chose.
- Proof By Contradiction
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