Abstract
We propose and test a model of asymmetric performance-based arbitrage. While short arbitrageurs are forced to reduce their positions after a negative return, positive returns have no immediate effect on their managed funds. This price reaction is bounded by short-selling costs, because while short selling activity may generate overshooting, transaction costs may keep it limited. This paper empirically tests model predictions using Brazilian short-selling data. We show that there is an overshooting after good news for highly shorted stocks, but it is offset by trading and shorting costs indicating that short selling bans may be unnecessary to smooth market conditions. We also find support to the behavioral feature of our model that suggests that arbitrageurs behave asymmetrically to the types of news.
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