Equilibrium and welfare in markets with financially constrained arbitrageurs

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We propose a multiperiod model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. In our model, arbitrage activity benefits all investors because arbitrageurs supply liquidity to the market. However, arbitrageurs might fail to take a socially optimal level of risk, in the sense that a change in their positions can make all investors better off. We characterize conditions under which arbitrageurs take too much or too little risk.

JEL-codes: F3 G3 (search for similar items in EconPapers)
Date: 2002-11
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Citations: View citations in EconPapers (501)

Published in Journal of Financial Economics, November, 2002, 66(2-3), pp. 361-407. ISSN: 0304-405X

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Related works:
Journal Article: Equilibrium and welfare in markets with financially constrained arbitrageurs (2002)
Working Paper: Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:448

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