On the Role of Arbitrageurs in Rational Markets

36 Pages Posted: 4 Dec 2003  

Benjamin Croitoru

McGill University - Desautels Faculty of Management

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2005

Abstract

We investigate the role of "arbitrageurs," who exploit price discrepancies between redundant securities. Arbitrage opportunities arise endogenously in an economy populated by rational, heterogeneous investors facing investment restrictions. We show that an arbitrageur alleviates these restrictions and improves the transfer of risk amongst investors. When the arbitrageur behaves noncompetitively, taking into account the price impact of his trades, he optimally limits the size of his positions due to his decreasing marginal profits. When the arbitrageur is subject to margin requirements and is endowed with capital from outside investors, the size of his trades and capital are endogenously determined in equilibrium.

Keywords: arbitrage, asset pricing, margin requirements, noncompetitive markets, risk-sharing

JEL Classification: C60, D50, D90, G11, G12

Suggested Citation

Croitoru, Benjamin and Basak, Suleyman, On the Role of Arbitrageurs in Rational Markets (October 2005). EFA 2004 Maastricht Meetings Paper No. 2390; AFA 2004 San Diego Meetings. Available at SSRN: https://ssrn.com/abstract=475483 or http://dx.doi.org/10.2139/ssrn.475483

Benjamin Croitoru

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
514-398-3237 (Phone)
514-398-3876 (Fax)

Suleyman Basak (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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