Does Arbitrage Flatten Demand Curves for Stocks?

43 Pages Posted: 3 Aug 2000  

Jeffrey Wurgler

NYU Stern School of Business; National Bureau of Economic Research (NBER)

Ekaterina Zhuravskaya

Paris School of Economics (PSE)

Multiple version iconThere are 3 versions of this paper

Date Written: June 2000

Abstract

In textbook theory, demand curves for stocks are kept flat by riskless arbitrage between perfect substitutes. In reality, however, individual stocks do not have perfect substitutes. The risk inherent in arbitrage between imperfect substitutes may deter risk-averse arbitrageurs from flattening demand curves. Consistent with this suggestion and a simple model of demand curves for stocks, we find that stocks without close substitutes experience differentially higher price jumps upon inclusion into the S&P 500 Index. We conjecture that arbitrage forces are weakest, and other pricing anomalies are severest, among stocks without close substitutes (which include small stocks).

JEL Classification: G1

Suggested Citation

Wurgler, Jeffrey and Zhuravskaya, Ekaterina, Does Arbitrage Flatten Demand Curves for Stocks? (June 2000). Yale SOM Working Paper No. ICF - 99-12. Available at SSRN: https://ssrn.com/abstract=235182 or http://dx.doi.org/10.2139/ssrn.235182

Jeffrey A. Wurgler (Contact Author)

NYU Stern School of Business ( email )

Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States
212-998-0367 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~jwurgler/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ekaterina V. Zhuravskaya

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

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