Journal
JOURNAL OF FINANCIAL ECONOMICS
Volume 66, Issue 2-3, Pages 361-407Publisher
ELSEVIER SCIENCE SA
DOI: 10.1016/S0304-405X(02)00228-3
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We propose a multiperiod 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. In our model, arbitrage activity benefits all investors because arbitrageurs supply liquidity to the market. However, arbitrageurs might fail to take a socially optimal level of risk, in the sense that a change in their positions can make all investors better off. We characterize conditions under which arbitrageurs take too much or too little risk. (C) 2002 Elsevier Science B.V. All rights reserved.
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