Financial Innovation in Segmented Markets

43 Pages Posted: 11 Feb 2004

See all articles by Rohit Rahi

Rohit Rahi

London School of Economics - Department of Finance; London School of Economics & Political Science (LSE) - Financial Markets Group

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group

Multiple version iconThere are 2 versions of this paper

Date Written: January 2004

Abstract

We analyse an equilibrium model with restricted investor participation in which strategic arbitrageurs play an innovation game and exploit the resulting mispricings by reaping trading profits. Since the equilibrium asset structure is not chosen by a social planner, it is chosen to maximize arbitrage profits and depends, therefore, realistically upon considerations such as depth, liquidity and gains from trade. In addition, the welfare properties of the resulting asset structure are studied. It is shown that the degree of inefficiency depends upon the heterogeneity of investors. The conjecture of the optimality of 'Macro Markets' is analysed formally in this framework.

Keywords: Asset innovation, arbitrage, restricted participation, innovation games

JEL Classification: D81, G18, G20

Suggested Citation

Rahi, Rohit and Zigrand, Jean-Pierre, Financial Innovation in Segmented Markets (January 2004). CEPR Discussion Paper No. 4176. Available at SSRN: https://ssrn.com/abstract=501981

Rohit Rahi (Contact Author)

London School of Economics - Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
+44 20 7955 7313 (Phone)
+44 20 7955 7420 (Fax)

HOME PAGE: http://vishnu.lse.ac.uk/

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6201 (Phone)
+44 20 7955 7420 (Fax)

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