Government Intervention and Arbitrage
101 Pages Posted: 25 May 2014 Last revised: 12 May 2017
Date Written: May 9, 2017
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: Suggested Citation