Dissecting Arbitrage Costs

We dissect the relative importance of nine commonly used measures of arbitragecosts on the extent of mispricing in the cross-section of stock returns. Using the relative valuationindex developed in Stambaugh, Yu, and Yuan (2012) to measure mispricing, we find that arbitrage risk, measuredusing idiosyncratic risk, is the predominant limiting arbitragecost. Information uncertainty and transactions costs are also important limiting factorsto arbitrage, but only among small stocks. A principal components analysis shows that arbitragecosts can be reduced into two significant dimensions. Overall the evidence suggests that arbitragecosts explain much of the average returns associated with stock anomalies.