52 The Journal of Finance mentioned,is that value stocks have historically earned higher returns than glamour stocks,but there are many others.Our analysis offers a different approach to understanding these anomalies than does the standard efficient markets theory. The efficient markets approach to these anomalies is to argue that higher returns must be compensation for higher systematic risk,and therefore the model of asset pricing that made the evidence look anomalous must have been misspecified.It must be possible to explain the anomalies away by finding a covariance between the returns on the anomalous portfolio and some funda- mental factor from the intertemporal capital asset pricing model or arbitrage pricing theory. The efficient markets approach is based on the assumption that most inves- tors,like the economists,see the available arbitrage opportunities and take them.Excess returns are eliminated by the action of a large number of such investors,each with only a limited extra exposure to any one set of securities. Excess returns to particular securities persist only if they are negatively correlated with state variables such as the aggregate marginal utility of consumption or wealth. As we argue in this article,the theoretical underpinnings of the efficient markets approach to arbitrage are based on a highly implausible assumption of many diversified arbitrageurs.In reality,arbitrage resources are heavily concentrated in the hands of a few investors that are highly specialized in trading a few assets,and are far from diversified.As a result,these investors care about total risk,and not just systematic risk.Since the equilibrium excess returns are determined by the trading strategies of these investors,looking for systematic risk as the only potential determinant of pricing is inappropriate. Idiosyncratic risk as well deters arbitrageurs,whether it is fundamental or noise trader idiosyncratic risk. Our article suggests a different approach to understanding anomalies.The first step is to understand the source of noise trading that might generate the mispricing in the first place.Specifically,it is essential to examine the demand of the potential noise traders,whether such demand is driven by sentiment or institutional restrictions on holdings.The second step is to evaluate the costs of arbitrage in the market,especially the total volatility of arbitrage returns. For a given noise trading process,volatile securities will exhibit greater mis- pricing and a higher average return to arbitrage in equilibrium.(Other costs of arbitrage,such as transaction costs,are also important(Pontiff(1996)). We can illustrate the difference between the two approaches using the value/glamour anomaly.To justify an efficient markets approach to explaining this anomaly,Fama and French(1992)argue that the capital asset pricing model is misspecified,and that high (low)book to market stocks earn a high (low)return because the former have a high loading on a different risk factor than the market.Although they don't precisely identify a macroeconomic factor to which the high book to market stocks are particularly exposed,they argue that the portfolio of high book to market stocks is itself a proxy for such a factor,which they call the distress factor