Dynamics of Arbitrage

63 Pages Posted: 25 Jul 2018

See all articles by Louis H. Ederington

Louis H. Ederington

University of Oklahoma - Division of Finance

Chitru S. Fernando

University of Oklahoma - Michael F. Price College of Business

Kateryna V. Holland

Purdue University - Division of Finance

Thomas K Lee

Energy Information Administration - US DOE

Scott C. Linn

University of Oklahoma - Michael F. Price College of Business

Date Written: June 4, 2018

Abstract

This paper examines the mechanism behind cash-and-carry arbitrage by studying the U.S. crude oil market. Sizable arbitrage-related inventory movements occur primarily at the NYMEX futures contract delivery point, but no evidence of such movements exists at other U.S. storage locations where, instead, operational factors explain most inventory changes. We add to the Theory of Storage literature by introducing two new features. First, due to arbitrageurs contracting ahead, inventories respond to not only contemporaneous but also lagged futures spreads. Second, storage capacity limits can impede cash-and-carry arbitrage leading to the persistence of unexploited arbitrage opportunities. Our findings suggest that arbitrage-induced inventory movements are, on average, price stabilizing.

Keywords: theory of storage, commodity markets, cash-and-carry arbitrage, financialization, spot oil markets, oil futures markets, oil storage

JEL Classification: G13, G18, Q41

Suggested Citation

Ederington, Louis H. and Fernando, Chitru S. and Holland, Kateryna V. and Lee, Thomas K. and Linn, Scott C., Dynamics of Arbitrage (June 4, 2018). Available at SSRN: https://ssrn.com/abstract=3208278 or http://dx.doi.org/10.2139/ssrn.3208278

Louis H. Ederington

University of Oklahoma - Division of Finance ( email )

Norman, OK 73019
United States
405-325-5591 (Phone)
405-325-7688 (Fax)

Chitru S. Fernando (Contact Author)

University of Oklahoma - Michael F. Price College of Business ( email )

Adams Hall
307 West Brooks Street
Norman, OK 73019-4004
United States
405-325-2906 (Phone)
405-325-7688 (Fax)

HOME PAGE: http://faculty-staff.ou.edu/F/Chitru.Fernando-1/

Kateryna V. Holland

Purdue University - Division of Finance ( email )

MGMT KRAN, 403 West State Street
West Lafayette, IN 47907-2056
United States

Thomas K. Lee

Energy Information Administration - US DOE ( email )

1000 Independence Avenue, SW
Washington, DC 20585
United States

Scott C. Linn

University of Oklahoma - Michael F. Price College of Business ( email )

307 West Brooks
Norman, OK 73019-4004
United States
405-325-3444 (Phone)
405-325-1957 (Fax)

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