Who Limits Arbitrage?

40 Pages Posted: 18 Apr 2019 Last revised: 12 May 2021

See all articles by Nathan Foley-Fisher

Nathan Foley-Fisher

Board of Governors of the Federal Reserve System

Borghan Narajabad

Board of Governors of the Federal Reserve System

Stephane Verani

Board of Governors of the Federal Reserve System

Date Written: July 1, 2020

Abstract

The cost of selling a security short is an equilibrium outcome of the demand for short positions and the willingness of long-term institutional investors to lend their securities to short sellers. We introduce an imperfectly competitive securities lending market into a model of securities traders with private information. Long-term institutional investors with greater liquidity risk tolerance are more willing to lend their securities, lowering the cost of taking short positions, which increases price informativeness in the spot trading market. We find empirical support for these predictions in the universe of corporate bond trades and life insurers' corporate bond loans.

Keywords: limits of arbitrage, securities lending, life insurers, corporate bonds, market

JEL Classification: G11, G22, G23

Suggested Citation

Foley-Fisher, Nathan and Narajabad, Borghan and Verani, Stephane, Who Limits Arbitrage? (July 1, 2020). Available at SSRN: https://ssrn.com/abstract=3361902 or http://dx.doi.org/10.2139/ssrn.3361902

Nathan Foley-Fisher (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Borghan Narajabad

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Stephane Verani

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/stephane-verani.htm

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