Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs

53 Pages Posted: 21 Nov 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: November 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. We derive an equilibrium and study its welfare properties. Allowing arbitrageurs to trade makes all investors better off. Arbitrageurs' positions may not be Pareto optimal, however, in the sense that a change in these positions may make all investors better off. We characterize conditions under which arbitrageurs take excessive or too little risk.

Keywords: Arbitrage, borrowing constraints, collateral, liquidity, welfare

JEL Classification: D62, G12, G18, G23, G30

Suggested Citation

Gromb, Denis and Vayanos, Dimitri, Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs (November 2001). CEPR Discussion Paper No. 3049. Available at SSRN: https://ssrn.com/abstract=290523

Denis Gromb (Contact Author)

HEC Paris

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Dimitri Vayanos

London School of Economics ( email )

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London WC2A 2AE
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+44 (0)20 7955 6382 (Phone)
+44 (0)20 7955 7420 (Fax)

Center for Economic Policy Research (CEPR)

London
United States

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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