Limits of Arbitrage: The State of the Theory
AbstractWe survey theoretical developments in the literature on the limits of arbitrage. This literature investigates how costs faced by arbitrageurs can prevent them from eliminating mispricings and providing liquidity to other investors. Research in this area is currently evolving into a broader agenda emphasizing the role of financial institutions and agency frictions for asset prices. This research has the potential to explain so-called \\market anomalies¶ and inform welfare and policy debates about asset markets. We begin with examples of demand shocks that generate mispricings, arguing that they can stem from behavioral or from institutional considerations. We next survey, and nest within a simple model, the following costs faced by arbitrageurs: (i) risk, both fundamental and non-fundamental, (ii) short-selling costs, (iii) leverage and margin constraints, and (iv) constraints on equity capital. We finally discuss implications for welfare and policy, and suggest directions for future research.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp650.
Date of creation: Mar 2010
Date of revision:
Contact details of provider:
Web page: http://www.lse.ac.uk/fmg/
Other versions of this item:
- D6 - Microeconomics - - Welfare Economics
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G1 - Financial Economics - - General Financial Markets
- G2 - Financial Economics - - Financial Institutions and Services
This paper has been announced in the following NEP Reports:
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Umar M. Mustapha, 2012. "The Role of Speculation in the Determination of Energy Prices," International Journal of Energy Economics and Policy, Econjournals, vol. 2(4), pages 279-291.
- Büyükşahin, Bahattin & Robe, Michel A., 2014. "Speculators, commodities and cross-market linkages," Journal of International Money and Finance, Elsevier, vol. 42(C), pages 38-70.
- Baker, Malcolm & Wurgler, Jeffrey & Yuan, Yu, 2012.
"Global, local, and contagious investor sentiment,"
Journal of Financial Economics,
Elsevier, vol. 104(2), pages 272-287.
- Malcolm Baker & Jeffrey Wurgler & Yu Yuan, 2009. "Global, local, and contagious investor sentiment," Globalization and Monetary Policy Institute Working Paper 37, Federal Reserve Bank of Dallas.
- Itzhak Ben-David & Francesco Franzoni & Rabih Moussawi, 2014. "Do ETFs Increase Volatility?," NBER Working Papers 20071, National Bureau of Economic Research, Inc.
- Kaminska, Iryna & Vayanos, Dimitri & Zinna, Gabriele, 2011.
"Preferred-habitat investors and the US term structure of real rates,"
Bank of England working papers
435, Bank of England.
- Iryna Kaminska & Dimitri Vayanos & Gabriele Zinna, 2011. "Preferred-Habitat Investors and the US Term Structure of Real Rates," FMG Discussion Papers dp674, Financial Markets Group.
- John H. Cochrane, 2011. "Discount Rates," NBER Working Papers 16972, National Bureau of Economic Research, Inc.
- Miguel Anton & Christopher Polk, 2010. "Connected stocks," LSE Research Online Documents on Economics 43098, London School of Economics and Political Science, LSE Library.
- Cai, Charlie X. & McGuinness, Paul B. & Zhang, Qi, 2011. "The pricing dynamics of cross-listed securities: The case of Chinese A- and H-shares," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2123-2136, August.
- D’Amico, Stefania & King, Thomas B., 2013. "Flow and stock effects of large-scale treasury purchases: Evidence on the importance of local supply," Journal of Financial Economics, Elsevier, vol. 108(2), pages 425-448.
- Casey B. Mulligan, 2011. "The Expanding Social Safety Net," NBER Working Papers 17654, National Bureau of Economic Research, Inc.
- Michael E. Cahill & Stefania D’Amico & Canlin Li & John S. Sears, 2013. "Duration risk versus local supply channel in Treasury yields: evidence from the Federal Reserve's asset purchase announcements," Finance and Economics Discussion Series 2013-35, Board of Governors of the Federal Reserve System (U.S.).
- Menkhoff, Lukas & Sarno, Lucio & Schmeling, Maik & Schrimpf, Andreas, 2012.
"Currency Momentum Strategies,"
CEPR Discussion Papers
8747, C.E.P.R. Discussion Papers.
- Lukas Menkhoff & Lucio Sarno & Maik Schmeling & Andreas Schrimpf, 2011. "Currency Momentum Strategies," BIS Working Papers 366, Bank for International Settlements.
- Lukas Menkhoff & Lucio Sarno & Maik Schmeling & Andreas Schrimpf, 2012. "Currency Momentum Strategies," Working Paper Series 09_12, The Rimini Centre for Economic Analysis.
- Ben-David, Itzhak & Franzoni, Francesco & Moussawi, Rabih, 2011. "ETFs, Arbitrage, and Contagion," Working Paper Series 2011-20, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
- Eric Belasco & Michael Finke & David Nanigian, 2012. "The impact of passive investing on corporate valuations," Managerial Finance, Emerald Group Publishing, vol. 38(11), pages 1067-1084, November.
- Wei Xiong, 2013. "Bubbles, Crises, and Heterogeneous Beliefs," NBER Working Papers 18905, National Bureau of Economic Research, Inc.
- Shakill Hassan & Sean Smith, 2011. "The Rand as a Carry Trade Target: Risk, Returns and Policy Implications," Working Papers 235, Economic Research Southern Africa.
- Jason Allen & James Chapman & Federico Echenique & Matthew Shum, 2012. "Efficiency and Bargaining Power in the Interbank Loan Market," Working Papers 12-29, Bank of Canada.
- Casey B. Mulligan, 2012. "Do Welfare Policies Matter for Labor Market Aggregates? Quantifying Safety Net Work Incentives since 2007," NBER Working Papers 18088, National Bureau of Economic Research, Inc.
- de la Torre, Augusto & Ize, Alain, 2013. "The foundations of macroprudential regulation : a conceptual roadmap," Policy Research Working Paper Series 6575, The World Bank.
- ap Gwilym, Owain & Wang, Qingwei & Hasan, Iftekhar & Xie, Ru, 2013. "In search of concepts: The effects of speculative demand on returns and volume," Research Discussion Papers 10/2013, Bank of Finland.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (The FMG Administration).
If references are entirely missing, you can add them using this form.