50 The JJournal of Finance stock market,either in the United States or abroad.6 Why is that so?Which markets attract arbitrage? Part of the answer is the ability of arbitrageurs to ascertain value with some confidence and to be able to realize it quickly.In the bond market,calculations of relative values of different fixed income instruments are doable,since future cash flows of securities are(almost)certain.As a consequence,there is almost no fundamental risk in arbitrage.In foreign exchange markets,calculations of relative values are more difficult,and arbitrage becomes riskier.However, arbitrageurs put on their largest trades,and appear to make the most money, when central banks attempt to maintain nonmarket exchange rates,so it is possible to tell that prices are not equal to fundamental values and to profit quickly.In stock markets,in contrast,both the absolute and the relative values of different securities are much harder to calculate.As a consequence, arbitrage opportunities are harder to identify in stock markets than in bond and foreign exchange markets. The discussion in this article suggests a further reason why some markets are more attractive for arbitrage than others.Unlike the well-diversified arbitrageurs of the conventional models,the specialized arbitrageurs of our model might avoid extremely volatile markets if they are risk averse. At first this claim seems counterintuitive,since high volatility may be associated with more frequent extreme mispricing,and hence more attractive opportunities for arbitrage.Assume that all volatility is due to noise trader sentiment and that the average out-performance of the arbitrageur relative to the benchmark,typically called alpha,is roughly proportional to the standard deviation of the noise trader demand shock.This means that if the arbitrageur switches to a market with twice the noise trader volatility,he also can expect twice the alpha per $1 investment.In such a market,by cutting his investment in half,the arbitrageur gets the same expected alpha and the same volatility as in the first market.He is indifferent to trading in these two markets because alpha per unit of risk is the same and he can always adjust his position to achieve the desired level of risk.This assumes that outside borrowing by the arbitrageur is limited not by the total dollar value of the investment,but by the dollar volatility of investment,which also seems plausible.In this simplified environment,the volatility of the market does not matter for the attractive- ness of entry by the marginal arbitrageur. High volatility does,however,make arbitrage less attractive if expected alpha does not increase in proportion to volatility.This would be true in particular when fundamental risk is a substantial part of volatility.For ex- ample,increasing one's equity position in an industry that is perceived to be underpriced carries substantial fundamental risk,and hence reduces the at- tractiveness of the trade.Another important factor determining the attractive- 6 Some of these activities,such as short-selling and use of leverage,are limited by government regulations or by fund charters.Many institutions such as mutual funds are also restricted in the degree to which their positions can be concentrated in a small number of securities and in their ability to keep their positions confidential