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The effect of arbitrage activity in beta and momentum strategies on abnormal trading profits

Knyazkina, Liudmila
Master thesis
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URI
http://hdl.handle.net/11250/2383124
Date
2015
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  • Master Thesis [3346]
Abstract
The purpose of this thesis is to investigate the effect of arbitrage activity on abnormal trading

profits based on the new measures of arbitrage proposed by Lou and Polk (2013) and Huang,

Lou and Polk (2014), called Comom and Cobar, respectively. First, I replicate the process of

Comom and Cobar construction and conduct an additional analysis of their specifications. I also

create a combined measure Comom/Cobar that measures arbitrage in both strategies

simultaneously. Second, I examine patterns of abnormal returns in momentum and beta strategy

conditional on the computed arbitrage measures. The study is conducted over the period January

1970 – December 2011.

The results of this paper indicate that such parameters as asset-pricing model and inclusion of

stocks below $5 into the sample do not affect the time series of the arbitrage measures, whereas

the choice of decile may significantly change the outcome. Consequently, I suggest using the

lowest decile for Comom and Cobar computation to avoid unrelated return comovements that

may arise in the highest deciles. I also find that Cobar and Comom cannot substitute each other

when used for abnormal return evaluation. After estimating abnormal returns through

constructed measures, I find that the effect of arbitrage activity does not create common patterns

in abnormal returns across beta and momentum strategies but rather produces specific price

reactions in each strategy.

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