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Outsized arbitrage

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  • Makarov, Igor

Abstract

The paper studies incentives and trading decisions of an arbitrageur who can take concentrated bets in an illiquid market and who cares about interim as well as long-term performance. By scaling up his position and using price impact, the arbitrageur can prop up the value of his position, helping him weather periods of low valuation and successfully complete the arbitrage. But that approach also can trap him into building an outsized arbitrage position, which can cause persistent mispricing in the market, even in the presence of other arbitrageurs, and lead to large losses to investors.

Suggested Citation

  • Makarov, Igor, 2020. "Outsized arbitrage," LSE Research Online Documents on Economics 118855, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:118855
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    File URL: http://eprints.lse.ac.uk/118855/
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    References listed on IDEAS

    as
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    JEL classification:

    • G00 - Financial Economics - - General - - - General

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