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Arbitrage and Endogenous Market Integration

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  • Jean-Pierre Zigrand

Abstract

We analyse a general equilibrium model of strategic arbitraging and intermediation. Arbitrageurs take advantage of mispricings, market frictions and manipulation opportunities in order to maximise profits. We analyse the effects of increased competition among arbitrageurs due to lower entry costs. Typically, markets become more liquid and integrated, and Cournot-Walas equilibria converge to Walrasian equilibria, though not uniformly: mispricings persist longer on shallow markets. We also provide a class of economies where the limiting equilibria are neither integrated nor Walrasian. Furthermore, we show that the asset pricing implications for financial innovations are quite different from standard models.

Suggested Citation

  • Jean-Pierre Zigrand, 1999. "Arbitrage and Endogenous Market Integration," FMG Discussion Papers dp319, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp319
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp319.pdf
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    Cited by:

    1. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407.
    2. Jun Liu, 2004. "Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities," The Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 611-641.
    3. Danielsson, Jon & Taylor, Ashley & Zigrand, Jean-Pierre, 2005. "Highwaymen or heroes: Should hedge funds be regulated?: A survey," Journal of Financial Stability, Elsevier, vol. 1(4), pages 522-543, October.
    4. Zigrand, Jean-Pierre, 2004. "A general equilibrium analysis of strategic arbitrage," Journal of Mathematical Economics, Elsevier, vol. 40(8), pages 923-952, December.
    5. Danielsson, Jon & Taylor, Ashley & Zigrand, Jean-Pierre, 2004. "Highwaymen or heroes: should hedge funds be regulated?," LSE Research Online Documents on Economics 24782, London School of Economics and Political Science, LSE Library.
    6. Zigrand, Jean-Pierre, 2001. "Rational limits to arbitrage," LSE Research Online Documents on Economics 25068, London School of Economics and Political Science, LSE Library.

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