On the role of arbitrageurs in rational markets |
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Authors: | Suleyman Basak Benjamin Croitoru |
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Institution: | 1. London Business School and CEPR, Regent''s Park, London NW1 4SA, UK;2. McGill University, 1001 Sherbrooke Street West, Montreal, Quebec, H3A 1G5 Canada |
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Abstract: | We investigate the role of “arbitrageurs,” who exploit price discrepancies between redundant securities. Arbitrage opportunities arise endogenously in an economy populated by rational, heterogeneous investors facing investment restrictions. We show that an arbitrageur alleviates these restrictions and improves the transfer of risk amongst investors. When the arbitrageur behaves noncompetitively, taking into account the price impact of his trades, he optimally limits the size of his positions due to his decreasing marginal profits. When the arbitrageur is subject to margin requirements and is endowed with capital from outside investors, the size of his trades and capital are endogenously determined in equilibrium. |
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Keywords: | C60 D50 D90 G11 G12 |
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