Limits to arbitrage and returns to value investing

We investigate the role played by limits to arbitrage (Shleifer, 2000; Shleifer and Vishny, 1997) on the abnormal returns earned by accounting-based fundamental analysis reported by the literature in the US markets (Piotroski, 2000; Monharam, 2005). We hypothesize that if limitations on the actions of arbitrageurs are partially responsible for these reported results, abnormal returns will be even higher in markets where such limitations are more impounding. Using Brazil as a laboratory and directly controlling for limitations to arbitrage our results confirm this hypothesis and show that firms with strong fundamentals only generate abnormal returns if there are restrictions to trade on their stocks.