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Information Exchange and the Limits of Arbitrage

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  • Gray, Wesley

Abstract

Evidence suggests that arbitragers exchange investment ideas. We analyze why and under what circumstances sharing occurs. Our model suggests that sharing ideas will lead to the following: more efficient asset prices, larger arbitrager profits, and correlated arbitrager returns. We predict that arbitragers will exchange ideas in markets where arbitragers are capital constrained, noise trader influence is high, and arbitrage investors are more loss averse. We also predict that arbitrage networks can lead to crowded trades, which can create systematic risk in extreme market circumstances.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 11918.

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Date of creation: 31 Nov 2008
Date of revision: 31 Nov 2008
Handle: RePEc:pra:mprapa:11918

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Keywords: arbitrage; hedge funds; market efficiency; information exchange; social networks; loss aversion; crowded trades;

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  1. Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 35(1), pages 45-70, April.
  2. Gray, Wesley & Kern, Andrew, 2008. "Fundamental Value Investors: Characteristics and Performance," MPRA Paper 12620, University Library of Munich, Germany.
  3. Paolo Colla & Antonio Mele, 2010. "Information Linkages and Correlated Trading," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 23(1), pages 203-246, January.
  4. Harrison Hong & Jeffrey D. Kubik & Jeremy C. Stein, 2005. "Thy Neighbor's Portfolio: Word-of-Mouth Effects in the Holdings and Trades of Money Managers," Journal of Finance, American Finance Association, American Finance Association, vol. 60(6), pages 2801-2824, December.
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  13. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  14. Shiller, 021Robert J. & Pound, John, 1989. "Survey evidence on diffusion of interest and information among investors," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 12(1), pages 47-66, August.
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  16. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, American Finance Association, vol. 25(2), pages 383-417, May.
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  19. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, Elsevier, vol. 9(1), pages 3-18, March.
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Cited by:
  1. Gray, Wesley & Kern, Andrew, 2008. "Fundamental Value Investors: Characteristics and Performance," MPRA Paper 12620, University Library of Munich, Germany.

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