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Equilibrium and welfare in markets with financially constrained arbitrageurs

Gromb, Denis and Vayanos, Dimitri (2002) Equilibrium and welfare in markets with financially constrained arbitrageurs. Journal of Financial Economics, 66 (2-3). pp. 361-407. ISSN 0304-405X

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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.

Item Type: Article
Official URL: http://www.elsevier.com/locate/jfec
Additional Information: Published 2002 © Elsevier Science B.V. LSE has developed LSE Research Online so that users may access research output of the School. Copyright © and Moral Rights for the papers on this site are retained by the individual authors and/or other copyright owners. Users may download and/or print one copy of any article(s) in LSE Research Online to facilitate their private study or for non-commercial research. You may not engage in further distribution of the material or use it for any profit-making activities or any commercial gain. You may freely distribute the URL (http://eprints.lse.ac.uk) of the LSE Research Online website.
Library of Congress subject classification: H Social Sciences > HG Finance
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Date Deposited: 09 Nov 2005
URL: http://eprints.lse.ac.uk/448/

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