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Rational Limits to Arbitrage

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  • Jean-Pierre Zigrand

Abstract

It is often argued that asset prices exhibit patterns incompatible with the behaviour of rational, optimizing agents. This paper proposes a rational framework which generates asset prices which appear irrational. This is accomplished by studying rational expectations equilibria in the presence of two realistic market frictions: immediacy risk (agents have to submit their demand functions before they know the equilibrium price) and asset-specific orders (investors have to submit one seperate demand for each asset, which may not be contingent upon the prices of the other assets). We study some of the properties of such equilibria, in particular the prevalence of arbitrage and of informational inefficiencies.

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  • Jean-Pierre Zigrand, 2001. "Rational Limits to Arbitrage," FMG Discussion Papers dp392, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp392
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp392.pdf
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    Cited by:

    1. 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.
    2. Zigrand, Jean-Pierre, 2004. "A general equilibrium analysis of strategic arbitrage," Journal of Mathematical Economics, Elsevier, vol. 40(8), pages 923-952, December.
    3. 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.

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