The Dynamics of Financially Constrained Arbitrage

Denis Gromb and Dimitri Vayanos

Journal of Finance, 2018, vol. 73, issue 4, 1713-1750

Abstract: We develop a model in which financially constrained arbitrageurs exploit price discrepancies across segmented markets. We show that the dynamics of arbitrage capital are self‐correcting: following a shock that depletes capital, returns increase, which allows capital to be gradually replenished. Spreads increase more for trades with volatile fundamentals or more time to convergence. Arbitrageurs cut their positions more in those trades, except when volatility concerns the hedgeable component. Financial constraints yield a positive cross‐sectional relationship between spreads/returns and betas with respect to arbitrage capital. Diversification of arbitrageurs across markets induces contagion, but generally lowers arbitrageurs' risk and price volatility.

Date: 2018
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Citations: View citations in EconPapers (33)

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https://doi.org/10.1111/jofi.12689

Related works:
Working Paper: The dynamics of financially constrained arbitrage (2018)
Working Paper: The dynamics of financially constrained arbitrage (2017)
Working Paper: The Dynamics of Financially Constrained Arbitrage (2015)
Working Paper: The dynamics of financially constrained arbitrage (2015)
Working Paper: The dynamics of financially constrained arbitrage (2015)
Working Paper: The Dynamics of Financially Constrained Arbitrage (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:73:y:2018:i:4:p:1713-1750

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