Limits-to-arbitrage, investment frictions, and innovation anomalies

This paper examines whether the limits-to-arbitrage and investment frictions hypotheses explain the research and development (R&D) premium. We find that the R&D premium is stronger for stocks that are hard to arbitrage and for stocks with investment frictions. The limits-to-arbitrage explanation explains more of the R&D premium than does the investment frictions explanation. Our results hold under the two-way sorts on limits-to-arbitrage and investment frictions measures. We also examine the impact of limits-to-arbitrage and investment frictions on innovation efficiency and R&D ability. We find that the limits-to-arbitrage and investment frictions are equally effective in explaining the two new innovation anomalies.