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Rational limits to arbitrage

Listed author(s):
  • Zigrand, Jean-Pierre
Registered author(s):

    It is often argued that asset prices exhibit patterns incompatible with the behaviour of rational, optimizing agents. This paper proposes a rational framework which generates asset prices which appear irrational. This is accomplished by studying rational expectations equilibria in the presence of two realistic market frictions: immediacy risk (agents have to submit their demand functions before they know the equilibrium price) and asset-specific orders (investors have to submit one seperate demand for each asset, which may not be contingent upon the prices of the other assets). We study some of the properties of such equilibria, in particular the prevalence of arbitrage and of informational inefficiencies.

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    File URL: http://eprints.lse.ac.uk/25068/
    File Function: Open access version.
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    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 25068.

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    Length: 31 pages
    Date of creation: Oct 2001
    Handle: RePEc:ehl:lserod:25068
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    1. Jean-Pierre Zigrand, 1999. "Arbitrage and Endogenous Market Integration," FMG Discussion Papers dp319, Financial Markets Group.
    2. Dow, James & Gorton, Gary, 1994. " Arbitrage Chains," Journal of Finance, American Finance Association, vol. 49(3), pages 819-849, July.
    3. Radner, Roy, 1979. "Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices," Econometrica, Econometric Society, vol. 47(3), pages 655-678, May.
    4. Kreps, David M., 1977. "A note on "fulfilled expectations" equilibria," Journal of Economic Theory, Elsevier, vol. 14(1), pages 32-43, February.
    5. Jordan, James S. & Radner, Roy, 1982. "Rational expectations in microeconomic models: An overview," Journal of Economic Theory, Elsevier, vol. 26(2), pages 201-223, April.
    6. Sanford J. Grossman, 1977. "The Existence of Futures Markets, Noisy Rational Expectations and Informational Externalities," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 431-449.
    7. Allen, Beth E, 1981. "Generic Existence of Completely Revealing Equilibria for Economies with Uncertainty when Prices Convey Information," Econometrica, Econometric Society, vol. 49(5), pages 1173-1199, September.
    8. Ausubel, Lawrence M., 1990. "Partially-revealing rational expectations equilibrium in a competitive economy," Journal of Economic Theory, Elsevier, vol. 50(1), pages 93-126, February.
    9. Klemperer, Paul D & Meyer, Margaret A, 1989. "Supply Function Equilibria in Oligopoly under Uncertainty," Econometrica, Econometric Society, vol. 57(6), pages 1243-1277, November.
    10. Heifetz, Aviad & Polemarchakis, Heracles M., 1998. "Partial Revelation with Rational Expectations," Journal of Economic Theory, Elsevier, vol. 80(1), pages 171-181, May.
    11. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
    12. Albert S. Kyle, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Oxford University Press, vol. 56(3), pages 317-355.
    13. Jean-Pierre Zigrand, 2005. "Rational Asset Pricing Implications from Realistic Trading Frictions," The Journal of Business, University of Chicago Press, vol. 78(3), pages 871-892, May.
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