Arbitrage Trading: The Long and the Short of It

We measure net arbitrage trading by the difference between abnormal hedge fund equity holdings and abnormal short interest on a stock. In the cross section, net arbitrage trading strongly predicts future stock returns. This predictability is not due to temporary price pressure, cannot be produced using total institutional holdings, but is consistent with information advantage and copycat trading. When examining a broad set of return anomalies, we find anomaly returns to come exclusively from the anomaly stocks traded by arbitrageurs, and such stocks are on average harder to arbitrage. Overall, our findings confirm that arbitrage trading is informative about mispricing.