The Impact of Arbitrage on Market Liquidity

60 Pages Posted: 20 Jul 2013 Last revised: 25 Jan 2018

Dominik Rösch

State University of New York at Buffalo - School of Management; Erasmus University - Rotterdam School of Management

Date Written: May 22, 2017

Abstract

I study deviations from the law of one price in Depositary Receipts using tick-by-tick data from the United States and 22 different home markets from 2001 to 2016. Deviations persist, on average, 12 minutes, and mainly arise because of demand pressure. Exploiting institutional details that create exogenous variation in the impediments to arbitrage within and across days, I show that absolute price deviations predict illiquidity, contemporaneously and in the future. Price deviations mainly predict the inventory costs component of the bid-ask spread. Thus, consistent with recent theory, these findings suggest that arbitrageurs tend to trade against demand pressure and thus enhance market integration and liquidity.

Keywords: arbitrage, liquidity, efficiency, fragmentation, market integration

JEL Classification: G14, G15

Suggested Citation

Rösch, Dominik, The Impact of Arbitrage on Market Liquidity (May 22, 2017). Paris December 2014 Finance Meeting EUROFIDAI - AFFI Paper. Available at SSRN: https://ssrn.com/abstract=2295437 or http://dx.doi.org/10.2139/ssrn.2295437

Dominik Rösch (Contact Author)

State University of New York at Buffalo - School of Management ( email )

Jacobs Management Center
Buffalo, NY 14222
United States

HOME PAGE: http://dominikroesch.com

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands

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