Abstract
I examine the effect of arbitrage risk on the alignment between stock prices and accounting fundamentals, where arbitrage risk is measured as the lack of close substitutes that can be used as a hedge. I find evidence consistent with the disparity between value and price being positively associated with arbitrage risk. Consistent with short-positions being more sensitive to arbitrage risk, my results are more pronounced for strategies that require short positions. I then show that the timeliness of the alignment between stock prices and accounting fundamentals is negatively related to arbitrage risk. My results provide empirical support for the hypothesis that price requires time to reflect accounting information and has implications for research that assumes that prices are measured without error.
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