Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs

51 Pages Posted: 12 Oct 2001

See all articles by Denis Gromb

Denis Gromb

HEC Paris

Dimitri Vayanos

London School of Economics; Center for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 22, 2001

Abstract

We propose a multi-period model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets, traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. In our model, arbitrage activity benefits all investors because arbitrageurs supply liquidity to the market. However, arbitrageurs may fail to take a socially optimal level of risk, in the sense that a change in their positions may make all investors better off. We characterize conditions under which arbitrageurs take too much or too little risk.

Suggested Citation

Gromb, Denis and Vayanos, Dimitri, Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs (October 22, 2001). AFA 2002 Atlanta Meetings. Available at SSRN: https://ssrn.com/abstract=286987 or http://dx.doi.org/10.2139/ssrn.286987

Denis Gromb

HEC Paris

1 rue de la Liberation
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France

Dimitri Vayanos (Contact Author)

London School of Economics ( email )

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Center for Economic Policy Research (CEPR)

London
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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