Financially constrained arbitrage and cross-market contagion
We propose a continuous time infinite horizon equilibrium model of financial markets in which arbitrageurs have multiple valuable investment opportunities but face financial constraints. The investment opportunities, heterogeneous along different dimensions, are provided by pairs of similar assets trading at different prices in segmented markets. By exploiting these opportunities, arbitrageurs alleviate the segmentation of markets, providing liquidity to other investors by intermediating their trades. We characterize the arbitrageurs' optimal investment policy, and derive implications for market liquidity and asset prices. We show that liquidity is smallest, volatility is largest, correlations between asset pairs with uncorrelated fundamentals are largest, and correlations between asset pairs with highly correlated fundamentals are smallest for intermediate levels of arbitrageur wealth.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:red:sed012:112. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.