The dynamics of financially constrained arbitrage

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

Abstract: We develop a model in which financially constrained arbitrageurs exploit price discrepancies across segmented markets. We show that the dynamics of arbitrage capital are self-correcting: following a shock that depletes capital, returns increase, and this allows capital to be gradually replenished. Spreads increase more for trades with volatile fundamentals or more time to convergence. Arbitrageurs cut their positions more in those trades, except when volatility concerns the hedgeable component. Financial constraints yield a positive cross-sectional relationship between spreads/returns and betas with respect to arbitrage capital. Diversification of arbitrageurs across markets induces contagion, but generally lowers arbitrageurs’ risk and price volatility.

Keywords: arbitrage; financial constraints; market segmentation; liquidity; contagion. (search for similar items in EconPapers)
JEL-codes: F3 G3 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2018-08-01
References: Add references at CitEc
Citations: View citations in EconPapers (26)

Published in Journal of Finance, 1, August, 2018, 73(4), pp. 1713 - 1750. ISSN: 0022-1082

Downloads: (external link)
http://eprints.lse.ac.uk/84081/ Open access version. (application/pdf)

Related works:
Journal Article: The Dynamics of Financially Constrained Arbitrage (2018)
Working Paper: The dynamics of financially constrained arbitrage (2017)
Working Paper: The Dynamics of Financially Constrained Arbitrage (2015)
Working Paper: The dynamics of financially constrained arbitrage (2015)
Working Paper: The dynamics of financially constrained arbitrage (2015)
Working Paper: The Dynamics of Financially Constrained Arbitrage (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:84081

Access Statistics for this paper

More papers in LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library LSE Library Portugal Street London, WC2A 2HD, U.K.. Contact information at EDIRC.
Bibliographic data for series maintained by LSERO Manager ().