Electronic Commerce, Spatial Arbitrage, and Market Efficiency

Electronic commerce can improve market efficiency by helping buyers and sellers find and transact with each other across geographic distance. We study the effect of two distinct forms of electronic commerce on market efficiency, which we measure via the existence and exploitation of spatial arbitrage opportunities. Spatial arbitrage represents a more precise measure of market efficiency than does price dispersion, which is typically used, because it accounts for the transaction costs of trading across distance and for unobserved product heterogeneity. One of the forms of electronic commerce that we study is a webcast channel that allows electronic access to the traditional physical market, while the other is a standalone electronic market. Both forms provide traders with expanded reach to find and transact with each other across geographic distance, but only one allows traders to conduct transactions immediately, at any time. This variance helps us isolate the effect of these mechanisms (reach and transaction immediacy) on efficiency. We find that electronic commerce reduces the number of arbitrage opportunities (likely by expanding traders’ geographic reach) but improves arbitrageurs’ ability to identify and exploit those that remain (likely by expanding arbitrageurs’ reach and providing them with the immediacy to exploit opportunities quickly). Overall, our results suggest that electronic commerce improves market efficiency not only by helping buyers and sellers transact across distance (thereby balancing supply and demand across geographic locations) but also by helping arbitrageurs quickly exploit any remaining arbitrage opportunities (thereby rebalancing supply and demand across geographic locations).