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Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs

  • Gromb, Denis
  • Vayanos, Dimitri

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
Date of revision:
Handle: RePEc:cpr:ceprdp:3049
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  1. repec:fth:starer:9825 is not listed on IDEAS
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  18. Tuckman, Bruce & Vila, Jean-Luc, 1993. "Holding Costs and Equilibrium Arbitrage," University of California at Los Angeles, Anderson Graduate School of Management qt41b480fn, Anderson Graduate School of Management, UCLA.
  19. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 309-41.
  20. Cuoco, Domenico, 1997. "Optimal Consumption and Equilibrium Prices with Portfolio Constraints and Stochastic Income," Journal of Economic Theory, Elsevier, vol. 72(1), pages 33-73, January.
  21. John Geanakoplos, 2001. "Liquidity, Default and Crashes: Endogenous Contracts in General Equilibrium," Cowles Foundation Discussion Papers 1316, Cowles Foundation for Research in Economics, Yale University.
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