LIMIT-TO-ARBITRAGE FACTORS AND IVOL RETURNS PUZZLE: EMPIRICAL EVIDENCE FROM TAIWAN BEFORE AND DURING COVID-19

This paper examines the impacts of limit-to-arbitrage factors on the returns of the idiosyncratic volatility (IVOL) puzzle in Taiwan before and during the Covid-19 pandemic. Although various studies explore the relationship between stock returns and IVOL, the empirical findings are mixed. We are motivated by unique market microstructures in Taiwan, such as individual investors' aggressive trading volume and low transaction costs in Taiwan, discouraging arbitrary trading activities. Our empirical results indicate a negative relationship between IVOL and stock returns by using data from the Taiwan stock market. However, the IVOL anomaly does not exist during the Covid-19 pandemic, even in the small stocks sample. Besides, our findings suggest that four proxies of limits-to-arbitrage, such as reversal, transaction costs, turnover and Amihud's Illiquidity, have statistically significant impacts on the return of IVOL anomaly in Taiwan except for the pandemic period. Finally, our finding suggests that the stock turnover is the only limit-to-arbitrage factor that helps investors earn arbitrary profits during the COVID-19 period. © 2021 World Scientific Publishing Company.