Costly Arbitrage and Skewness Pricing : Evidence from a First-day Price Limit Reform in China

We examine the effect of limits to arbitrage on skewness pricing using a reform of China's stock market that limits first-day price movements. We document that the reform causes a significant increase in the impact of IPOs' expected skewness on both their initial returns and trading interference effect, especially for IPO firms that are sensitive to the limitations imposed by price limits. We also find that the skewness pricing effect triggered by the reform persists along the idiosyncratic (not systematic) dimension. The results are consistent with the notion that price movement constraints contribute to limits to arbitrage and hence have a positive effect on skewness pricing