Arbitrage Networks

35 Pages Posted: 7 Jul 2009 Last revised: 17 Nov 2013

See all articles by Rohit Rahi

Rohit Rahi

London School of Economics - Department of Finance; London School of Economics & Political Science (LSE) - Financial Markets Group

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group

Date Written: November 16, 2013

Abstract

This paper studies the general equilibrium implications of arbitrage trades in segmented financial markets. Arbitrageurs choose a category of trades to specialize in. This results in an equilibrium network in which the various market segments are linked by arbitrageurs. Arbitrageurs exert externalities on each other depending on their position in the network. Due to these externalities, the complete network architecture, in which all links are feasible, is in general suboptimal for arbitrageurs; it is dominated by a hub-spoke architecture. The hub acts as a repository of liquidity, facilitating trades with minimal price impact. For an arbitrary architecture, as the mass of arbitrageurs grows, equilibrium prices converge to those of the frictionless economy with no segmentation. On the other hand, even if the architecture is complete, equilibrium networks may not be complete or even connected, regardless of the mass of arbitrageurs.

Keywords: Arbitrage, segmented markets, networks, externalities

JEL Classification: D53, D85

Suggested Citation

Rahi, Rohit and Zigrand, Jean-Pierre, Arbitrage Networks (November 16, 2013). Available at SSRN: https://ssrn.com/abstract=1430560 or http://dx.doi.org/10.2139/ssrn.1430560

Rohit Rahi (Contact Author)

London School of Economics - Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
+44 20 7955 7313 (Phone)

HOME PAGE: http://https://sites.google.com/lse.ac.uk/rohit-rahi

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6201 (Phone)
+44 20 7955 7420 (Fax)

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