The Limits of Arbitrage.¶
Shleifer, A., & Vishny, R. W. (1997). The Limits of Arbitrage. The Journal of Finance, 52(1), 35-55.
Cited by¶
7 citations across 6 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This sourceModels specialized arbitrageurs running other people's capital whose performance-based funds can be withdrawn precisely when mispricings widen; this 'performance-based arbitrage' mechanism breaks the textbook assumption of unlimited arbitrage capacity and explains why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.
Supported in partVerified against the publisher's abstract
Abstract: specialized arbitrageurs run other people's capital and arbitrage fails in extremes when prices diverge from fundamentals -- supports the mechanism, not the 2008/COVID episodes.
“In reality, almost all arbitrage requires capital, and is typically risky. Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances, when prices diverge far from …”
- 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.
Supported in partVerified against the publisher's abstract
The abstract backs the general frame that real arbitrage needs capital, is risky, and can fail so mispricings persist, but it does not name the four specific risk types or capital-constraint mechanism the claim lists.
“Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital, and is typically risky. Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that …”
- 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)
- T2: Limits to Arbitrage Preserve Sustained Mispricings. As Shleifer and Vishny (1997) formalize, EMH rests on the mechanism that arbitrage by rational traders corrects mispricings.
Supported in partVerified against the publisher's abstract
Abstract supports that arbitrage can fail and prices can diverge from fundamentals, but not that Shleifer & Vishny formalize EMH's corrective mechanism.
“Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances, when prices diverge far from fundamental values.”
- T2: Limits to Arbitrage Preserve Sustained Mispricings. As Shleifer and Vishny (1997) formalize, EMH rests on the mechanism that arbitrage by rational traders corrects mispricings.
- 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." 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').
Supported in partVerified against the publisher's abstract
Shleifer & Vishny's abstract states the frame the claim rests on: arbitrage is risky, run with other people's capital, and can become ineffective in extreme circumstances when prices diverge from fundamentals.
“Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances, when prices diverge far from fundamental values.”
- 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
- In economics no-arbitrage arguments show that if a price differential persisted, unbounded profit would follow, contradicting equilibrium, so the differential cannot persist.
Supported in partVerified against the publisher's abstract
The abstract supplies the textbook frictionless premise (arbitrage needs no capital and carries no risk) but its thesis is that real arbitrage is risky and fails, so it does not supply the derivation by contradiction.
“Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital, and is typically risky. Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital.”
- In economics no-arbitrage arguments show that if a price differential persisted, unbounded profit would follow, contradicting equilibrium, so the differential cannot persist.
Mechanisms¶
- Arbitrage Opportunity Scan
- Limits to arbitrage
This sourceShows that real-world arbitrage is risky and capital-dependent, so mispricing can deepen and persist when arbitrageurs become constrained.
- Limits to arbitrage
Verification¶
Does it exist? Confirmed. This work's DOI resolves to a registered record, which fixes its identity. That is all it fixes.
Does it back the claim? Read against the text for 5 of 7 citations: 5 supported in part. Each verdict is shown under its citation below, with what in the work backs the sentence.
Was it audited? Yes. A second, independent pass read the citation against the article text and recorded a verdict.
Support is checked per citation rather than per work — the same source can be cited soundly in one article and wrongly in another. Per-citation recording began recently, so a citation with no recorded check is a gap in the record rather than evidence it went unchecked.
See how references were verified.
Registry ID ref:6eab7f2496b0 · see in the full table