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Strategic Financial Innovation in Segmented Markets

  • Rahi, Rohit
  • Zigrand, Jean-Pierre

We analyse an equilibrium model with restricted investor participation in which strategic arbitrageurs play an innovation game and exploit the resulting mispricings by reaping trading profits. Since the equilibrium asset structure is not chosen by a social planner, it is chosen to maximize arbitrage profits and depends therefore realistically upon considerations such as depth, liquidity and gains from trade. In addition, the welfare properties of the resulting asset structure are studied. It is shown that the degree of inefficiency depends upon the heterogeneity of investors. The conjecture of the optimality of ‘Macro Markets’ is analysed formally in this framework.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4176.

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Date of creation: Jan 2004
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Handle: RePEc:cpr:ceprdp:4176
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  1. Franklin Allen, Douglas Gale, 1988. "Optimal Security Design," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 229-263.
  2. Kevin Dowd & David Blake & Andrew J. G. Cairns & Paul Dawson, 2006. "Survivor Swaps," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(1), pages 1-17.
  3. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2007. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," Journal of Finance, American Finance Association, vol. 62(2), pages 557-595, 04.
  4. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
  5. Zigrand, Jean-Pierre, 2006. "Endogenous market integration, manipulation and limits to arbitrage," Journal of Mathematical Economics, Elsevier, vol. 42(3), pages 301-314, June.
  6. Zigrand, Jean-Pierre, 2004. "A general equilibrium analysis of strategic arbitrage," Journal of Mathematical Economics, Elsevier, vol. 40(8), pages 923-952, December.
  7. Rahi Rohit, 1995. "Optimal Incomplete Markets with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 65(1), pages 171-197, February.
  8. JASKOLD GABSZEWICZ, Jean & VIAL, Jean-Philippe, . "Oligopoly "à la Cournot" in a general equilibrium analysis," CORE Discussion Papers RP -106, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  9. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 287-325.
  10. Allen, Franklin & Santomero, Anthony M., 1997. "The theory of financial intermediation," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1461-1485, December.
  11. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
  12. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
  13. Massa, Massimo & Peyer, Urs & Tong, Zhenxu, 2005. "Limits of Arbitrage and Corporate Financial Policy," CEPR Discussion Papers 4829, C.E.P.R. Discussion Papers.
  14. Demange Gabrielle & Laroque Guy, 1995. "Optimality of Incomplete Markets," Journal of Economic Theory, Elsevier, vol. 65(1), pages 218-232, February.
  15. Duffie Darrell & Rahi Rohit, 1995. "Financial Market Innovation and Security Design: An Introduction," Journal of Economic Theory, Elsevier, vol. 65(1), pages 1-42, February.
  16. Cuny, Charles J, 1993. "The Role of Liquidity in Futures Market Innovations," Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 57-78.
  17. Paul Willen, 2005. "New financial markets: who gains and who loses," Economic Theory, Springer, vol. 26(1), pages 141-166, 07.
  18. Peter DeMarzo & Darrell Duffie, 1999. "A Liquidity-Based Model of Security Design," Econometrica, Econometric Society, vol. 67(1), pages 65-100, January.
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