Investments, tenth edition

  Implementation Costs   

Exploiting overpricing can be particularly difficult. Short-

selling a security entails costs; short-sellers may have to return the borrowed security on 

little notice, rendering the horizon of the short sale uncertain; other investors such as many 

pension or mutual fund managers face strict limits on their discretion to short securities. 

This can limit the ability of arbitrage activity to force prices to fair value.  

  Model Risk 

  

One always has to worry that an apparent profit opportunity is more 

apparent than real. Perhaps you are using a faulty model to value the security, and the 

price actually is right. Mispricing may make a position a good bet, but it is still a risky one, 

which limits the extent to which it will be pursued.   

  Limits to Arbitrage and the Law of One Price 

 While one can debate the implications of much of the anomalies literature, surely the Law 

of One Price (positing that effectively identical assets should have identical prices) should 

be satisfied in rational markets. Yet there are several instances where the law seems to have 

been violated. These instances are good case studies of the limits to arbitrage.