The article by Jeffrey Wurgler and Ekaterina Zhuravskaya explores whether arbitrage truly flattens demand curves for stocks, as traditionally taught in financial theory. The authors argue that in reality, individual stocks do not have perfect substitutes, which limits the effectiveness of arbitrage. They develop a model to capture the role of arbitrage and its limitations, showing that risk aversion among arbitrageurs deters them from completely flattening demand curves. Empirical tests using stocks added to the S&P 500 Index support their model's predictions. High-arbitrage-risk stocks experience higher price jumps upon inclusion, and the price response increases with both the size of the demand shock and the stock's arbitrage risk. The results suggest that typical between-stock arbitrage trades are too risky to be worth the small gains they offer, and that stocks without close substitutes are more likely to exhibit mispricing. The authors conclude that arbitrage risk is one of several forces that can inhibit market efficiency, alongside informational and transaction costs, heterogeneous beliefs, and agency costs.The article by Jeffrey Wurgler and Ekaterina Zhuravskaya explores whether arbitrage truly flattens demand curves for stocks, as traditionally taught in financial theory. The authors argue that in reality, individual stocks do not have perfect substitutes, which limits the effectiveness of arbitrage. They develop a model to capture the role of arbitrage and its limitations, showing that risk aversion among arbitrageurs deters them from completely flattening demand curves. Empirical tests using stocks added to the S&P 500 Index support their model's predictions. High-arbitrage-risk stocks experience higher price jumps upon inclusion, and the price response increases with both the size of the demand shock and the stock's arbitrage risk. The results suggest that typical between-stock arbitrage trades are too risky to be worth the small gains they offer, and that stocks without close substitutes are more likely to exhibit mispricing. The authors conclude that arbitrage risk is one of several forces that can inhibit market efficiency, alongside informational and transaction costs, heterogeneous beliefs, and agency costs.