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Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs

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Author Info
Gromb, Denis
Vayanos, Dimitri
Abstract

We propose a multi-period model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets, traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. We derive an equilibrium and study its welfare properties. Allowing arbitrageurs to trade makes all investors better off. Arbitrageurs' positions may not be Pareto optimal, however, in the sense that a change in these positions may make all investors better off. We characterize conditions under which arbitrageurs take excessive or too little risk.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3049.

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Date of creation: Nov 2001
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Handle: RePEc:cpr:ceprdp:3049

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Related research
Keywords: arbitrage; borrowing constraints; collateral; liquidity; welfare;

Find related papers by JEL classification:
D62 - Microeconomics - - Welfare Economics - - - Externalities
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
G23 - Financial Economics - - Financial Institutions and Services - - - Pension Funds; Other Private Financial Institutions
G30 - Financial Economics - - Corporate Finance and Governance - - - General

Cited by:
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  1. Marcelo Pinheiro, 2005. "Informational asymmetries and a multiplier effect on price correlation and trading," Annals of Finance, Springer, vol. 1(4), pages 395-421, October. [Downloadable!] (restricted)
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This page was last updated on 2009-12-31.

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