Working Paper: NBER ID: w29744
Authors: Eduardo Dvila; Daniel D Graves; Cecilia Parlatore
Abstract: This paper studies the social value of closing price differentials in financial markets. We show that arbitrage gaps (price differentials between markets) exactly correspond to the marginal social value of executing an arbitrage trade. We further show that arbitrage gaps and measures of price impact are sufficient to compute the total social value from closing an arbitrage gap. Theoretically, we show that, for a given arbitrage gap, the total social value of arbitrage is higher in more liquid markets. We apply our framework to compute the welfare gains from closing arbitrage gaps in the context of covered interest parity violations and several dual-listed companies. The estimates of the value of closing arbitrage gaps vary substantially across applications.
Keywords: arbitrage; financial markets; social value; price differentials; welfare gains
JEL Codes: D61; G12; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| arbitrage gap (D50) | marginal social welfare gain (D69) |
| arbitrage gap (D50) | total social value of arbitrage (D46) |
| market liquidity (G10) | social value for a given arbitrage gap (D46) |
| scale of arbitrage trades (G13) | social welfare (I38) |