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A Theory of Arbitrage Capital

Author

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  • Viral V. Acharya
  • Hyun Song Shin
  • Tanju Yorulmazer

Abstract

We present a model of equilibrium allocation of capital for arbitrage. If asset prices may fall low enough, it is profitable to carry liquid capital to acquire assets in such states. Set against this, keeping capital in liquid form entails costs in terms of foregone profitable investments. This trade-off generates occasional fire sales and limited arbitrage capital as robust phenomena. With learning-by-doing effects, arbitrage capital moves in to acquire assets only if fire sales are steep. However, once arbitrage capital finds it profitable to acquire assets, it requires similar returns elsewhere, inducing contagious fire-sale prices even for unrelated assets.

Suggested Citation

  • Viral V. Acharya & Hyun Song Shin & Tanju Yorulmazer, 2013. "A Theory of Arbitrage Capital," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 2(1), pages 62-97.
    • Handle: RePEc:oup:rcorpf:v:2:y:2013:i:1:p:62-97.
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    3. Park, Hyun Woong & Bernardin, Thomas, 2018. "Liquidity, bank runs, and fire sales under local thinking," The North American Journal of Economics and Finance, Elsevier, vol. 46(C), pages 89-102.
    4. Tatiana Beliaeva & Galina Shirokova & William Wales & Elena Gafforova, 2020. "Benefiting from economic crisis? Strategic orientation effects, trade-offs, and configurations with resource availability on SME performance," International Entrepreneurship and Management Journal, Springer, vol. 16(1), pages 165-194, March.
    5. Justine Pedrono, 2022. "The Currency Channel of the Global Bank Leverage Cycle," Working papers 870, Banque de France.
    6. Abbassi, Puriya & Iyer, Rajkamal & Peydró, José-Luis & Tous, Francesc R., 2016. "Securities trading by banks and credit supply: Micro-evidence from the crisis," Journal of Financial Economics, Elsevier, vol. 121(3), pages 569-594.
    7. Choi, Dong Beom & Eisenbach, Thomas M. & Yorulmazer, Tanju, 2021. "Watering a lemon tree: Heterogeneous risk taking and monetary policy transmission," Journal of Financial Intermediation, Elsevier, vol. 47(C).
    8. Emil Siriwardane, 2014. "Using proprietary credit default swap (CDS) data from 2010 to 2014, I show that capital fluctuations for sellers of CDS protection are an important determinant of CDS spread movements. I first establi," Working Papers 14-10, Office of Financial Research, US Department of the Treasury, revised 12 Feb 2015.
    9. Guowei Li & Zhe Luo & Muhammad Anwar & Yuqiu Lu & Xiantao Wang & Xuening Liu, 2020. "Intellectual capital and the efficiency of SMEs in the transition economy China; Do financial resources strengthen the routes?," PLOS ONE, Public Library of Science, vol. 15(7), pages 1-25, July.
    10. Abbassi, Puriya & Iyer, Rajkamal & Peydró, José-Luis & Tous, Francesc R., 2016. "Securities trading by banks and credit supply: Micro-evidence from the crisis," Journal of Financial Economics, Elsevier, vol. 121(3), pages 569-594.
    11. Sinha, Pankaj & Grover, Naina, 2019. "Estimation of liquidity created by banks in India," MPRA Paper 92563, University Library of Munich, Germany.
    12. DeLisle, R. Jared & McTier, Brian C. & Smedema, Adam R., 2016. "Systematic limited arbitrage and the cross-section of stock returns: Evidence from exchange traded funds," Journal of Banking & Finance, Elsevier, vol. 70(C), pages 118-136.
    13. Fenghua Song & Anjan V. Thakor, 2023. "Market Freeze and Bank Capital Structure Heterogeneity," Management Science, INFORMS, vol. 69(3), pages 1856-1876, March.

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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • D62 - Microeconomics - - Welfare Economics - - - Externalities

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