Financial Innovation in Segmented Markets

Rahi, Rohit; Zigrand, Jean-Pierre

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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

There 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: Suggested Citation

Rahi, Rohit and Zigrand, Jean-Pierre, Financial Innovation in Segmented Markets (January 2004). Available at SSRN: https://ssrn.com/abstract=501981