DP15235 Fast and Slow Arbitrage: Fund Flows and Mispricing in the Frequency Domain

Author(s): Xi Dong, NAMHO KANG, Joël Peress
Publication Date: August 2020
Keyword(s): Hedge Funds, Limits to Arbitrage, Market Efficiency, Mutual funds, pricing anomalies, return persistence and cyclicality/seasonality, Slow-moving capital, Spectral analysis, transaction costs
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15235

Using spectral analysis, we document that hedge fund and mutual fund flows explain much of the persistence and cyclicality of anomaly returns. Indeed, they correct and amplify mispricing slowly, 24 and 4 times more, respectively, over horizons longer than one year compared with shorter horizons . Passive fund flows, in contrast, have no effect on mispricing. Over long horizons, hedge fund flows are most influential among fund types on a per-dollar basis . Hedge fund managers, rather than investors, helm this "slow-moving" effect, and frictions explain their behavior. We propose a model highlighting the horizon-dependent effects of capital on market efficiency.