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Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market

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Author Info
Olivier Vigneron,
Xavier Gabaix
Arvind Krishnamurthy

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Abstract

``Limits of Arbitrage" theories require that the marginal investor in a particular asset market be a specialized arbitrageur. Then the constraints faced by this arbitrageur (i.e. capital constraints) feed through into asset prices. We examine the mortgage-backed securities (MBS) market in this light, as casual empiricism suggests that investors in the MBS market do seem to be very specialized. We show that risks that seem relatively minor for aggregate wealth are priced in the MBS market. A simple pricing kernel based on the aggregate value of MBS securities prices risk in the MBS market. The evidence suggests that limits of arbitrage theories can help explain the behavior of spreads in this market.

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 430.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:430

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Related research
Keywords: Market segmentation; prepayment risk; liquidity; limited capital; hedge funds; limits to arbitrage;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ricardo J. Caballero & Arvind Krishnamurthy, 2007. "Collective Risk Management in a Flight to Quality Episode," NBER Working Papers 12896, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Ralph S.J Koijen & Otto Van Hemert & Stijn Van Nieuwerburgh, 2007. "Mortgage Timing," NBER Working Papers 13361, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Paul Willen & Felix Kubler, 2006. "Collateralized borrowing and life-cycle portfolio choice," Public Policy Discussion Paper 06-4, Federal Reserve Bank of Boston. [Downloadable!]
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  4. Sumit Agarwal & John C. Driscoll & David Laibson, 2007. "Optimal Mortgage Refinancing: A Closed Form Solution," NBER Working Papers 13487, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Greenwood, Robin & Vayanos, Dimitri, 2008. "Bond Supply and Excess Bond Returns," CEPR Discussion Papers 6694, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  6. Robin Greenwood & Dimitri Vayanos, 2008. "Bond Supply and Excess Bond Returns," NBER Working Papers 13806, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. John Y. Campbell, 2006. "Household Finance," NBER Working Papers 12149, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Nicolae Garleanu & Lasse Heje Pedersen & Allen M. Poteshman, 2005. "Demand-Based Option Pricing," NBER Working Papers 11843, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Francis A. Longstaff & Jun Pan & Lasse H. Pedersen & Kenneth J. Singleton, 2007. "How Sovereign is Sovereign Credit Risk?," NBER Working Papers 13658, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Christopher J. Neely & Paul A. Weller, 2007. "Central bank intervention with limited arbitrage," Working Papers 2006-033, Federal Reserve Bank of St. Louis. [Downloadable!]
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  11. Zhiguo He & Wei Xiong, 2008. "Multi-market Delegated Asset Management," NBER Working Papers 14574, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Chris Edmond & Pierre-Olivier Weill, 2009. "Aggregate Implications of Micro Asset Market Segmentation," NBER Working Papers 15254, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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