The purpose of this thesis is to investigate the effect of arbitrage activity on abnormal tradingprofits based on the new measures of arbitrage proposed by Lou and Polk (2013) and Huang,Lou and Polk (2014), called Comom and Cobar, respectively. First, I replicate the process ofComom and Cobar construction and conduct an additional analysis of their specifications. I alsocreate a combined measure Comom/Cobar that measures arbitrage in both strategiessimultaneously. Second, I examine patterns of abnormal returns in momentum and beta strategyconditional on the computed arbitrage measures. The study is conducted over the period January1970 – December 2011.The results of this paper indicate that such parameters as asset-pricing model and inclusion ofstocks below $5 into the sample do not affect the time series of the arbitrage measures, whereasthe choice of decile may significantly change the outcome. Consequently, I suggest using thelowest decile for Comom and Cobar computation to avoid unrelated return comovements thatmay arise in the highest deciles. I also find that Cobar and Comom cannot substitute each otherwhen used for abnormal return evaluation. After estimating abnormal returns throughconstructed measures, I find that the effect of arbitrage activity does not create common patternsin abnormal returns across beta and momentum strategies but rather produces specific pricereactions in each strategy.
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