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Arbitrage with financial constraints and market power

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  • Fardeau, Vincent

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.

Suggested Citation

  • Fardeau, Vincent, 2024. "Arbitrage with financial constraints and market power," Journal of Economic Theory, Elsevier, vol. 217(C).
    • Handle: RePEc:eee:jetheo:v:217:y:2024:i:c:s0022053124000310
    DOI: 10.1016/j.jet.2024.105825
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    More about this item

    Keywords

    Strategic arbitrage; Liquidity; Market structure; Margin requirements; VaR; Volcker Rule;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • D60 - Microeconomics - - Welfare Economics - - - General

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