Investor Sentiment, Limited Arbitrage, and the Cash Holding Effect

Li, Xiafei; Luo, Di

Abstract

We examine the investor sentiment and limits-to-arbitrage explanations for the positive cross-sectional relation between cash holdings and future stock returns. Consistent with the investor sentiment hypothesis, we find that the cash holding effect is significant when sentiment is low, and it is insignificant when sentiment is high. In addition, the cash holding effect is strong among stocks with high transaction costs, high short selling costs, and large idiosyncratic volatility, indicating that arbitrage on the cash holding effect is costly and risky. In line with the limits-to-arbitrage hypothesis, high costs and risk prevent rational investors from exploiting the cash holding effect.

Citation

Li, X., & Luo, D. (2017). Investor Sentiment, Limited Arbitrage, and the Cash Holding Effect. Review of Finance, 21(6), 2141-2168. https://doi.org/10.1093/rof/rfw031

• Journal Article Type: Article
• Acceptance Date: May 4, 2016
• Online Publication Date: Jun 22, 2016
• Publication Date: 2017-10
• Deposit Date: Oct 17, 2016
• Publicly Available Date: Oct 17, 2016
• Journal: Review of Finance
• Print ISSN: 1572-3097
• Electronic ISSN: 1573-692X
• Publisher: Oxford University Press
• Peer Reviewed: Peer Reviewed
• Volume: 21
• Issue: 6
• Pages: 2141-2168
• DOI: https://doi.org/10.1093/rof/rfw031
• Keywords: Cash holding investor sentiment, Transaction costs, Idiosyncratic volatility
• Public URL: https://nottingham-repository.worktribe.com/output/885676
• Publisher URL: https://academic.oup.com/rof/article-abstract/21/6/2141/2670103
• Additional Information: This is a pre-copyedited, author-produced PDF of an article accepted for publication in Review of Finance following peer review. The version of record: Xiafei Li, Di Luo, Investor Sentiment, Limited Arbitrage, and the Cash Holding Effect, Review of Finance, Volume 21, Issue 6, October 2017, Pages 2141–2168, https://doi.org/10.1093/rof/rfw031; is available online at: https://academic.oup.com/rof/article-abstract/21/6/2141/2670103