Turning Alphas into Betas : Arbitrage and Endogenous Risk

This paper tests the idea that financial intermediaries who act as arbitrageurs in the asset market help determine the equilibrium risk of financial assets. They do this by turning “alphas” into “betas”; assets with large abnormal returns attract more arbitrage and covary correspondingly more with systematic shocks to arbitrage capital. I show that this prediction explains the cross-sectional variation in the funding liquidity and the arbitrageur wealth portfolio betas of equity anomaly portfolios. My results highlight that intermediaries who act as arbitrageurs not only price cross-sections of assets given risks, but also actively shape these risks through the act of arbitrage