Arbitrage Crashes and the Speed of Capital

54 Pages Posted: 22 Jun 2010 Last revised: 9 Nov 2013

See all articles by Mark L. Mitchell

Mark L. Mitchell

University of Chicago - Booth School of Business; AQR Capital Management, LLC; CNH Partners

Todd C. Pulvino

AQR Capital Management, LLC; CNH Partners

Date Written: May 27, 2011

Abstract

The imminent failure of large Wall Street prime brokerage firms during the 2008 financial crisis caused a sudden and dramatic decrease in the amount of financial leverage afforded hedge funds. This decrease in financing resulted from the ex post asymmetrical payoff to rehypothecation lenders – the ultimate providers of financing, through prime brokers, to hedge funds. Seemingly long-term debt capital became short-term capital creating a large mismatch in the duration of arbitrage opportunities on the left-hand side of arbitrageurs’ balance sheet and liabilities on the right-hand side. A primary consequence of this withdrawal of financing was the inability of hedge funds involved in relative-value trades to maintain prices of substantially similar assets at substantially similar prices. The magnitudes of these mispricings, and the time required to correct them, provide an indication of the role played by arbitrageurs in maintaining rational prices during normal times.

Keywords: Limited Arbitrage, Financial Crisis

Suggested Citation

Mitchell, Mark L. and Pulvino, Todd C., Arbitrage Crashes and the Speed of Capital (May 27, 2011). Available at SSRN: https://ssrn.com/abstract=1628261 or http://dx.doi.org/10.2139/ssrn.1628261

Mark L. Mitchell

University of Chicago - Booth School of Business ( email )

5807 S Woodlawn Ave
Chicago, IL 60637
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

CNH Partners ( email )

One Greenwich Plaza
2nd Floor
Greenwich, CT 06830
United States
(203) 742-3001 (Phone)

Todd C. Pulvino (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

CNH Partners ( email )

2 Greenwich Plaza
1st Floor
Greenwich, CT 06830
United States
203-742-3002 (Phone)
203-742-3072 (Fax)

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