Arbitrage Chains

Posted: 10 Aug 1999

See all articles by Gary B. Gorton

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Multiple version iconThere are 2 versions of this paper

Date Written: March 1993.

Abstract

In efficient markets prices should reflect the arrival of private information. A trader will engage in costly arbitrage if: (1) the information in his order is not immediately reflected in the asset's price; and (2) he can hold the asset until the date when the information is reflected. We study a general equilibrium model of optimizing agents where each period there may be a trader with a limited horizon and private information about a distant event. Whether he, and subsequent informed traders, act on this information is shown to depend on the possibility of a sequence or chain of future informed traders spanning the event date. An arbitrageur who receives good news will buy only if it is likely that a subsequent arbitrageurs' buying will have pushed up the expected price by the time he wishes to sell. We show that limited trading horizons result in inefficient prices because informed traders do not act on their information until the event date is sufficiently close.

JEL Classification: G12, G14

Suggested Citation

Gorton, Gary B., Arbitrage Chains (March 1993.). Available at SSRN: https://ssrn.com/abstract=5343

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

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HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

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Yale University - Yale Program on Financial Stability

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P.O. Box 208200
New Haven, CT 06520-8200
United States

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