Research On The Theory Of Limited Arbitrage

Modern financial theory established on two cornerstones between the Efficient Market Hypothesis (EMH) and the Capital Asset Pricing Model (CAPM), Its models and paradigms were confined to the "rational" framework when analysis , while ignored the ability of the investors' behavior in the actual decision-making. With more and more anomalies were being found in financial markets, however modern financial theory couldn't give a perfect explanation, so people doubt the effectiveness and predictability of the theory. On this condition, during the 1980s behavioral finance rose quietly, to give people a new perspective insight the financial markets.Behavioral finance theory relax the assumption of rational people in modern finance theory, with a realistic view to study decision-making behavior of the investors, base on the mentality and behavior of investors and limited arbitrage, establish their own theoretical system. This paper first questioned EHM, then introduced the background of the behavioral finance and presented its theoretical cornerstones, elaborated my view that arbitrage was not described as modern finance that needed no risks could gain value. After that combined the actual situation in China to focus on the limited arbitrage theory, and discussed the applicability of the securities market in China, pointed out that due to reasons of institution and investors, arbitrage in china securities market would have to bear greater risk. Finally quoted a classic example of the limitedarbitrage------Closed-end Fund Discount Puzzle. Use the method of behavioral Finance to give a brief explanation, to calculate the Hurst index of Closed-end Fund Discount by R/S analysis method, then contrast with the result of fund index and Shanghai Stock Index, combine with the limited arbitrage theory to design a arbitrage tactics. The results showed that: 1, On the beginning closed-end funds at a premium, especially before 2000 the newly established closed-end funds at high premium, soon after started to discount, and most of the time at a discount status; 2, Closed-end funds discount have little relation with the performance of the stock market and fund market; 3, In different market quotation closed-end funds discount has not shown the same continuity.This study enrich the limited arbitrage theory, especially for those who want to further researching. In this paper, the latest data of closed-end funds has being used, and groundbreaking for different market quotation with different means, base on discount and combine with limited arbitrage to design a arbitrage strategy, have reality significance in guiding for investors.