Limited Arbitrage in Equity Markets


  • Mark Mitchell,

  • Todd Pulvino,

  • Erik Stafford

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    • 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.


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 limits arbitrage.