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Is Arbitrage Socially Beneficial?

E. Glen Weyl

Microsoft Research; Yale University

October 15, 2007

Economists often associate information efficiency of prices with allocative (Pareto) efficiency. When arbitrageurs connect segmented markets to correct a misallocation of risk, this assumption is sound. However, when opportunities for arbitrage or financial innovation arise from mispricings caused by the presence of confused investors or other distortions, such market-making is harmful. Rather than arbitrage facilitating the flow of risk to those who can most efficiently bear it, this harmful arbitrage allocates risk to those who least understand it. The beneficial effects of efficient pricing on real investment decision mitigate the harms caused by arbitrage, but also limits its benefits by providing substitute insurance. Even when arbitrage is not strictly harmful, it may be oversupplied, especially given that it typically employ some of the most talented workers.

Number of Pages in PDF File: 19

Keywords: arbitrage, social welfare, behavioral finance, credit crisis

JEL Classification: D52, D61, D82, G18

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Date posted: January 8, 2009  

Suggested Citation

Weyl, E. Glen, Is Arbitrage Socially Beneficial? (October 15, 2007). Available at SSRN: https://ssrn.com/abstract=1324423 or http://dx.doi.org/10.2139/ssrn.1324423

Contact Information

Eric Glen Weyl (Contact Author)
Microsoft Research ( email )
641 Avenue of the Americas
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New York, NY 10011
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(857) 998-4513 (Phone)
HOME PAGE: http://www.glenweyl.com
Yale University ( email )
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New Haven, CT 06520-8268
United States
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