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The Value of Arbitrage

Author

Listed:
  • Eduardo Dávila
  • Daniel Graves
  • Cecilia Parlatore

Abstract

This paper studies the social value of closing price differentials in financial markets. We show that arbitrage gaps exactly correspond to the marginal social value of executing an arbitrage trade. Moreover, arbitrage gaps and price impact measures are sufficient to compute the total social value from closing an arbitrage gap, which may emerge for different reasons, including nonpecuniary benefits of holding particular assets. Theoretically, we show that, for a given arbitrage gap, the total social value of arbitrage is higher in more liquid markets. We compute the welfare gains from closing arbitrage gaps for covered interest parity violations.

Suggested Citation

  • Eduardo Dávila & Daniel Graves & Cecilia Parlatore, 2024. "The Value of Arbitrage," Journal of Political Economy, University of Chicago Press, vol. 132(6), pages 1947-1993.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/728453
    DOI: 10.1086/728453
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    Cited by:

    1. Balakin, Sergei & Roger, Guillaume, 2025. "Dynamic trading strategies for storage," Journal of Economic Dynamics and Control, Elsevier, vol. 176(C).
    2. Damoun, Anas & Poudineh, Rahmatallah, 2025. "Economics of electricity grid interconnections: A heterogeneous markets’ design context," Energy Economics, Elsevier, vol. 152(C).

    More about this item

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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