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Dynamics of Arbitrage

Author

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  • Ederington, Louis H.
  • Fernando, Chitru S.
  • Holland, Kateryna V.
  • Lee, Thomas K.
  • Linn, Scott C.

Abstract

We study the dynamics of cash-and-carry arbitrage using the U.S. crude oil market. Sizable arbitrage-related inventory movements occur at the New York Mercantile Exchange (NYMEX) futures contract delivery point but not at other storage locations, where instead, operational factors explain most inventory changes. We add to the theory-of-storage literature by introducing two new features. First, due to arbitrageurs contracting ahead, inventories respond to not only contemporaneous but also lagged futures spreads. Second, storage-capacity limits can impede cash-and-carry arbitrage, leading to the persistence of unexploited arbitrage opportunities. Our findings suggest that arbitrage-induced inventory movements are, on average, price stabilizing.

Suggested Citation

  • Ederington, Louis H. & Fernando, Chitru S. & Holland, Kateryna V. & Lee, Thomas K. & Linn, Scott C., 2021. "Dynamics of Arbitrage," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 56(4), pages 1350-1380, June.
    • Handle: RePEc:cup:jfinqa:v:56:y:2021:i:4:p:1350-1380_8
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    Cited by:

    1. Gilbert, Christopher L., 2022. "Warehouse load-out queues and aluminum prices," Journal of Commodity Markets, Elsevier, vol. 28(C).
    2. Kim, Jaeho & Linn, Scott C., 2022. "Price discovery under model uncertainty," Energy Economics, Elsevier, vol. 107(C).
    3. V., Ernesto Guerra & H., Eugenio Bobenrieth & H., Juan Bobenrieth & Wright, Brian D., 2023. "Endogenous thresholds in energy prices: Modeling and empirical estimation," Energy Economics, Elsevier, vol. 121(C).
    4. Nikitopoulos, Christina Sklibosios & Thomas, Alice Carole & Wang, Jianxin, 2023. "The economic impact of daily volatility persistence on energy markets," Journal of Commodity Markets, Elsevier, vol. 30(C).
    5. Fan, John Hua & Qiao, Xiao, 2023. "Commodity momentum: A tale of countries and sectors," Journal of Commodity Markets, Elsevier, vol. 29(C).

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