Arbitrage with Financial Constraints and Market Power

67 Pages Posted: 26 Jun 2020 Last revised: 19 Apr 2021

See all articles by Vincent Fardeau

Vincent Fardeau

National Research University Higher School of Economics - International College of Economics and Finance

Date Written: April 5, 2021

Abstract

I study how (VaR-based) financial constraints affect liquidity and welfare under different structures of the arbitrage industry. When capital is spread across numerous competitive arbitrageurs, financial constraints may impair their ability to provide liquidity, lowering other investors' welfare. However, when capital is concentrated among arbitrageurs with market power, introducing constraints can make everyone better off and increase liquidity. Further, alternative constraints (fixed margins, position limits) have the same effects as VaR constraints when arbitrageurs are competitive, but not when they have market power. These results suggest that margin and capital requirements should take the market structure into account.

Keywords: Limits of arbitrage, liquidity, strategic arbitrage, market structure, price impact, margin requirements, market power

JEL Classification: G12, D41, D60

Suggested Citation

Fardeau, Vincent, Arbitrage with Financial Constraints and Market Power (April 5, 2021). Proceedings of Paris December 2020 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3630914 or http://dx.doi.org/10.2139/ssrn.3630914

Vincent Fardeau (Contact Author)

National Research University Higher School of Economics - International College of Economics and Finance ( email )

Pokrovski Bulvar 11, Korpus Zh, Office 715
Moscow, 109028
Russia

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