Working Paper: CEPR ID: DP4176
Authors: Rohit Rahi; Jean-Pierre Zigrand
Abstract: We analyse an equilibrium model with restricted investor participation in which strategic arbitrageurs play an innovation game and exploit the resulting mispricings by reaping trading profits. Since the equilibrium asset structure is not chosen by a social planner, it is chosen to maximize arbitrage profits and depends therefore realistically upon considerations such as depth, liquidity and gains from trade. In addition, the welfare properties of the resulting asset structure are studied. It is shown that the degree of inefficiency depends upon the heterogeneity of investors. The conjecture of the optimality of ?Macro Markets? is analysed formally in this framework.
Keywords: Arbitrage; Asset Innovation; Innovation Games; Restricted Participation
JEL Codes: D81; G18; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic actions of arbitrageurs (C70) | level of mispricing in the market (G19) |
| investor heterogeneity (G11) | outcomes of arbitrage strategies (G19) |
| strategic decisions made by arbitrageurs (G11) | welfare properties of the asset structure (G32) |