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Information Exchange and the Limits of Arbitrage

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  • Gray, Wesley

Abstract

Evidence suggests that arbitragers exchange investment ideas. We analyze why and under what circumstances sharing occurs. Our model suggests that sharing ideas will lead to the following: more efficient asset prices, larger arbitrager profits, and correlated arbitrager returns. We predict that arbitragers will exchange ideas in markets where arbitragers are capital constrained, noise trader influence is high, and arbitrage investors are more loss averse. We also predict that arbitrage networks can lead to crowded trades, which can create systematic risk in extreme market circumstances.

Suggested Citation

  • Gray, Wesley, 2008. "Information Exchange and the Limits of Arbitrage," MPRA Paper 12621, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:12621
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    1. Gray, Wesley & Kern, Andrew, 2008. "Fundamental Value Investors: Characteristics and Performance," MPRA Paper 12620, University Library of Munich, Germany.

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    More about this item

    Keywords

    Arbitrage; hedge funds; market efficiency; information exchange; loss aversion; crowded trades;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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