Feedback effects and the limits to arbitrage
By: Alex Edmans, Itay Goldstein, Wei Jiang
Contributors: Goldstein, Itay; Jiang, Wei; National Bureau of Economic Research
Series: NBER working paper series -- working paper 17582; Working paper series (National Bureau of Economic Research : Online) -- working paper no. 17582.
Publisher: National Bureau of Economic Research
Published: 2011
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Description: "This paper identifies a limit to arbitrage that arises from the fact that a firm's fundamental value is endogenous to the act of exploiting the arbitrage.  Trading on private information reveals this information to managers and helps them improve their real decisions, in turn enhancing fundamental value.  While this increases the profitability of a long position, it reduces the profitability of a short position -- selling on negative information reveals that firm prospects are poor, causing the manager to cancel investment.  Optimal abandonment increases firm value and may cause the speculator to realize a loss on her initial sale.  Thus, investors may strategically refrain from trading on negative information, and so bad news is incorporated more slowly into prices than good news.  The effect has potentially important real consequences -- if negative information is not incorporated into stock prices, negative-NPV projects may not be abandoned, leading to overinvestment"--National Bureau of Economic Research web site.
Notes: Title from PDF file as viewed on 1/12/2012.

Includes bibliographical references.

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