On the Role of Arbitrageurs in Rational Markets
McGill University - Desautels Faculty of Management
London Business School; London Business School; Centre for Economic Policy Research (CEPR)
EFA 2004 Maastricht Meetings Paper No. 2390; AFA 2004 San Diego Meetings
We investigate the role of "arbitrageurs," who exploit price discrepancies between redundant securities. Arbitrage opportunities arise endogenously in an economy populated by rational, heterogeneous investors facing investment restrictions. We show that an arbitrageur alleviates these restrictions and improves the transfer of risk amongst investors. When the arbitrageur behaves noncompetitively, taking into account the price impact of his trades, he optimally limits the size of his positions due to his decreasing marginal profits. When the arbitrageur is subject to margin requirements and is endowed with capital from outside investors, the size of his trades and capital are endogenously determined in equilibrium.
Number of Pages in PDF File: 36
Keywords: arbitrage, asset pricing, margin requirements, noncompetitive markets, risk-sharing
JEL Classification: C60, D50, D90, G11, G12
Date posted: December 4, 2003
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