Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs

Denis Gromb and Dimitri Vayanos

No 3049, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We propose a multi-period model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets, traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. We derive an equilibrium and study its welfare properties. Allowing arbitrageurs to trade makes all investors better off. Arbitrageurs' positions may not be Pareto optimal, however, in the sense that a change in these positions may make all investors better off. We characterize conditions under which arbitrageurs take excessive or too little risk.

Keywords: Arbitrage; Borrowing constraints; Collateral; Liquidity; Welfare (search for similar items in EconPapers)
JEL-codes: D62 G12 G18 G23 G30 (search for similar items in EconPapers)
Date: 2001-11
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Citations: View citations in EconPapers (31)

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Related works:
Journal Article: Equilibrium and welfare in markets with financially constrained arbitrageurs (2002)
Working Paper: Equilibrium and welfare in markets with financially constrained arbitrageurs (2002)
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