Arbitrage with financial constraints and market power

Vincent Fardeau

Journal of Economic Theory, 2024, vol. 217, issue C

Abstract: I study how (VaR-based) financial constraints affect liquidity and welfare under different structures of the arbitrage industry. When capital is dispersed across competitive arbitrageurs, financial constraints may impair their ability to provide liquidity, lowering other investors' welfare. However, when capital is concentrated among arbitrageurs with market power, introducing constraints can make everyone better off and increase liquidity. Further, alternative constraints (fixed margins, position limits) have the same effects as VaR constraints when arbitrageurs are competitive, but not when they have market power. These results lead to new policy implications for margin and capital requirements and yield new empirical predictions.

Keywords: Strategic arbitrage; Liquidity; Market structure; Margin requirements; VaR; Volcker Rule (search for similar items in EconPapers)
JEL-codes: D41 D60 G12 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:217:y:2024:i:c:s0022053124000310

DOI: 10.1016/j.jet.2024.105825

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