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Strategic Financial Innovation in Segmented Markets

  • Jean-Pierre Zigrand


  • Rohit Rahi


We study an equilibrium model with restricted investor participation in which strategic arbitrageurs reap profits by exploiting mispricings across different trading locations. We edogonize the asset structure as the outcome of the security design game played by the arbitrageurs. The equilibrium asset structure depends realistically upon consideration such as depth, liquidity and gains from trade. It is not socially optimal in general; the degree of inefficiency depends upon the heterogeneity of investors. Finally we use this framework to formally analyse Shiller's conjecture of the optimality 'macro markets'.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp520.

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Date of creation: Oct 2004
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Handle: RePEc:fmg:fmgdps:dp520
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  1. 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.
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  5. Olivier Vigneron, & Xavier Gabaix & Arvind Krishnamurthy, 2004. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," Econometric Society 2004 North American Summer Meetings 430, Econometric Society.
  6. Zigrand, Jean-Pierre, 2006. "Endogenous market integration, manipulation and limits to arbitrage," Journal of Mathematical Economics, Elsevier, vol. 42(3), pages 301-314, June.
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  8. Allen, Franklin & Santomero, Anthony M., 1997. "The theory of financial intermediation," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1461-1485, December.
  9. J. M. Culbertson, 1957. "The Term Structure of Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 71(4), pages 485-517.
  10. 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.
  11. 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).
  12. 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.
  13. Rahi Rohit, 1995. "Optimal Incomplete Markets with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 65(1), pages 171-197, February.
  14. 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.
  15. Peter DeMarzo & Darrell Duffie, 1999. "A Liquidity-Based Model of Security Design," Econometrica, Econometric Society, vol. 67(1), pages 65-100, January.
  16. Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
  17. Zigrand, Jean-Pierre, 2004. "A general equilibrium analysis of strategic arbitrage," Journal of Mathematical Economics, Elsevier, vol. 40(8), pages 923-952, December.
  18. Massa, Massimo & Peyer, Urs & Tong, Zhenxu, 2005. "Limits of Arbitrage and Corporate Financial Policy," CEPR Discussion Papers 4829, C.E.P.R. Discussion Papers.
  19. Demange Gabrielle & Laroque Guy, 1995. "Optimality of Incomplete Markets," Journal of Economic Theory, Elsevier, vol. 65(1), pages 218-232, February.
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