 Liquidity Risk and the Dynamics of Arbitrage CapitalPéter Kondor and Dimitri Vayanos Journal of Finance, 2019, vol. 74, issue 3, 1139-1173 Abstract: We develop a continuous‐time model of liquidity provision in which hedgers can trade multiple risky assets with arbitrageurs. Arbitrageurs have constant relative risk‐aversion (CRRA) utility, while hedgers' asset demand is independent of wealth. An increase in hedgers' risk aversion can make arbitrageurs endogenously more risk‐averse. Because arbitrageurs generate endogenous risk, an increase in their wealth or a reduction in their CRRA coefficient can raise risk premia despite Sharpe ratios declining. Arbitrageur wealth is a priced risk factor because assets held by arbitrageurs offer high expected returns but suffer the most when wealth drops. Aggregate illiquidity, which declines in wealth, captures that factor. Date: 2019 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:74:y:2019:i:3:p:1139-1173 Ordering information: This journal article can be ordered from Access Statistics for this article More articles in Journal of Finance from American Finance Association Contact information at EDIRC. |
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