Inference, arbitrage, and asset price volatility

Tobias Adrian ()

Journal of Financial Intermediation, 2009, vol. 18, issue 1, pages 49-64

Abstract: Does the presence of arbitrageurs decrease equilibrium asset price volatility? I study an economy with arbitrageurs, informed investors, and noise traders. Arbitrageurs face a trade-off between "inference" and "arbitrage": they would like to buy assets in response to temporary price declines--the arbitrage effect--but sell when prices decline permanently--the inference effect. In equilibrium, the presence of arbitrageurs increases volatility when the inference effect dominates the arbitrage effect. From a technical point of view, the paper offers closed form solutions to a dynamic equilibrium model with asymmetric information and non-Gaussian priors.

Keywords: Asset; pricing; Learning; Asymmetric; information; Limits; to; arbitrage (search for similar items in EconPapers)
Date: 2009

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Working Paper: Inference, arbitrage, and asset price volatility (2004)
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Persistent link: http://EconPapers.repec.org/RePEc:eee:jfinin:v:18:y:2009:i:1:p:49-64

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