Does Arbitrage Flatten Demand Curves for Stocks?

Posted: 24 Apr 2001

See all articles by Jeffrey Wurgler

Jeffrey Wurgler

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

Ekaterina Zhuravskaya

Paris School of Economics (PSE)

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Abstract

In the classic theory of Scholes (1972), demand curves for stocks are kept flat by riskless arbitrage between perfect substitutes. In reality, however, individual stocks do not have perfect substitutes. We develop a simple model of demand curves for stocks in which the risk inherent in arbitrage between imperfect substitutes deters risk-averse arbitrageurs from flattening demand curves. Consistent with the model, stocks without close substitutes experience higher price jumps upon inclusion into the S&P 500 Index. The results suggest that arbitrage is weaker, and mispricing is likely to be more frequent and more severe, among stocks without close substitutes.

Keywords: Arbitrage

JEL Classification: G1

Suggested Citation

Wurgler, Jeffrey A. and Zhuravskaya, Ekaterina, Does Arbitrage Flatten Demand Curves for Stocks?. The Journal of Business, Vol. 75, No. 4, October 2002. Available at SSRN: https://ssrn.com/abstract=258528

Jeffrey A. Wurgler (Contact Author)

NYU Stern School of Business ( email )

Stern School of Business
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HOME PAGE: http://www.stern.nyu.edu/~jwurgler/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Ekaterina Zhuravskaya

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

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