The Limits of Arbitrage 53 Our approach instead would be to identify the pattern of investor sentiment responsible for this anomaly,as well as the costs of arbitrage that would keep it from being eliminated.To begin,the glamour-value evidence is consistent with some investors extrapolating past earnings growth of companies and failing to recognize that extreme earnings growth is likely to revert to the mean (Lakonishok,Shleifer,and Vishny(1994),LaPorta(1996)).With respect to risk,the conventional arbitrage of the glamour-value anomaly,i.e.,simply taking a long position in a diversified portfolio of value(high book-to-market) stocks,has been roughly a 60-40 proposition over a one year horizon.That is, the odds of outperforming the S&P 500 index over one year have been only 60 percent,although over 5 years the superior performance has been much more likely.8 Over a short horizon,then,arbitrage returns on the value portfolio are volatile.Even though this risk may be idiosyncratic,it cannot be hedged by arbitrageurs specializing in this segment of the market.Because of the high volatility of the hedge strategy,and the relatively long horizon it relies on to secure positive returns with a high probability,it is likely to be shunned by arbitrageurs,particularly those with a short track record. Our approach further implies that,in extreme situations,arbitrageurs try- ing to eliminate the glamour/value mispricing might lose enough money that they have to liquidate their positions.In this case,arbitrageurs may become the least effective in reducing the mispricing precisely when it is the greatest. Something along these lines occurred with the stocks of commercial banks in 1990-1991.As the prices of these stocks fell sharply,many traditional value arbitrageurs invested heavily in these stocks.However,the prices kept falling, and many value arbitrageurs lost most of their funds under management.As a consequence,they had to liquidate their positions,which put further pres- sure on the prices of banking stocks.After this period,the returns on banking stocks have been very high,but many value funds did not last long enough to profit from this recovery. The glamour/value anomaly is one of several that our approach might explain.The analysis actually predicts what types of market anomalies can persist over the long term.These anomalies must have a high degree of unpredictability,which makes betting against them risky for specialized ar- bitrageurs.However,unlike in the efficient markets model,this risk need not be correlated with any macroeconomic factors,and can be purely idiosyncratic fundamental or noise trader risk. Finally,the specialized arbitrage approach assumes that only a relatively small number of specialists understand the return anomaly well enough to exploit it.This may be questionable in the case of anomalies like the value- glamour anomaly or the small firm anomaly about which there is now much published work.As more investors begin to understand an anomaly,the superior returns to the trading strategy may be diminished by the actions of a larger number of investors who each tilt their portfolios toward the under- priced assets.Alternatively,investors may become more knowledgeable about s The exact odds depend on what sample period and what universe of stocks is used