Behavioral Finance: Limits to Arbitrage

Vocabulary flashcards covering key terms and concepts related to Behavioral Finance and Limits to Arbitrage.

Arbitrageur

An individual who knows the fundamental price but may not be able to find a truly riskless trade to enforce price equivalence.

Limits to Arbitrage

Impediments that prevent arbitrageurs from restoring prices to fundamental value.

Noise Trading

Trading based on irrational beliefs or non-informational motives, often pushing prices away from their fundamental values.

Textbook Arbitrage

Simultaneous purchase and sale of the same or similar security in different markets for riskless profit.

Long-Short Trades

A trading strategy that involves buying underpriced assets and selling overpriced assets.

Fundamental Risk

The risk that a mispriced asset's price may not reflect fundamental values due to inherent uncertainties.

Transaction Costs

Costs incurred during trading, including short-sales costs, that can limit arbitrage effectiveness.

Dual-Listed Companies (DLCs)

Companies that have shares traded in different countries but are claims on the same cash flow.

Rebate Rate

The interest rate that short sellers receive, which can vary based on the stock's borrowability.

Short Sales Costs

Costs associated with short selling, including borrowing fees and potential price increases.

Performance-Based Arbitrage

A form of arbitrage where fund managers are influenced by their past performance, affecting their willingness to take risks.

Noise Trader Risk

The risk that irrational behavior of other traders can exacerbate mispricing and deter arbitrage.

Idiosyncratic Risk

Risk that is unique to a particular asset or small group of assets and cannot be mitigated through diversification.

Market Efficiency Hypothesis (EMH)

The theory that asset prices fully reflect all available information.