Arbitraging Arbitrageurs

45 Pages Posted: 31 Jul 2003 Last revised: 16 Jul 2009

See all articles by Mukarram Attari

Mukarram Attari

CRA International, Incorporated

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Martin E. Ruckes

Karlsruhe Institute of Technology

Date Written: October 2005

Abstract

This paper develops a theory of strategic trading in markets with large influential arbitrageurs. If arbitrageurs are not very well-capitalized, margin requirements or capital constraints make their trades predictable. Other market participants can exploit this by trading against them. Competitors may even find it optimal to lend to arbitrageurs that are financially fragile; additional capital makes the arbitrageurs more viable, and lenders can reap profits from trading against them for a longer time. The strategic behavior of these market participants has implications for the functioning of financial markets. Strategic trading may produce significant price distortions, increase price manipulation activities, and trigger forced liquidations of large traders.

Suggested Citation

Attari, Mukarram and Mello, Antonio S. and Ruckes, Martin E., Arbitraging Arbitrageurs (October 2005). The Journal of Finance, Vol. 60, No. 5, pp. 2471-2511, 2005, EFA 2003 Annual Conference Paper No. 478, Available at SSRN: https://ssrn.com/abstract=424366 or http://dx.doi.org/10.2139/ssrn.424366

Mukarram Attari

CRA International, Incorporated ( email )

1201 F. St. NW
Ste. 700
Washington, DC 20004
United States
617-425-3336 (Phone)

Antonio S. Mello (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3423 (Phone)
608-265-4195 (Fax)

Martin E. Ruckes

Karlsruhe Institute of Technology ( email )

Kaiserstra├če 12
Karlsruhe, Baden W├╝rttemberg 76131
Germany

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