Government Intervention and Arbitrage

101 Pages Posted: 25 May 2014 Last revised: 12 May 2017

See all articles by Paolo Pasquariello

Paolo Pasquariello

University of Michigan, Stephen M. Ross School of Business

Date Written: May 9, 2017

Abstract

Direct government intervention in a market may induce violations of the law of one price in other, arbitrage-related markets. I show that a government pursuing a non-public, partially informative price target in a model of strategic market-order trading and segmented dealership generates equilibrium price differentials among fundamentally identical assets by clouding dealers' inference about the targeted asset's payoff from its order flow, to an extent complexly dependent on existing price formation. I find supportive evidence using a sample of American Depositary Receipts and other cross-listings traded in the major U.S. exchanges, along with currency interventions by developed and emerging countries between 1980 and 2009.

Keywords: Arbitrage, Law of One Price, Central Bank, Government Intervention, Currency Market, ADR, Cross-Listing, Liquidity, Strategic Trading

JEL Classification: F31, G14, G15

Suggested Citation

Pasquariello, Paolo, Government Intervention and Arbitrage (May 9, 2017). Ross School of Business Paper No. 1240. Available at SSRN: https://ssrn.com/abstract=2441195 or http://dx.doi.org/10.2139/ssrn.2441195

Paolo Pasquariello (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

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