Seminar

Financially Constrained Arbitrage and Cross-Market Contagion

Denis Gromb (INSEAD and CEPR)

November 23, 2009, 12:30–14:00

Room MF 323

Paul Woolley Research Initiative Seminar

Abstract

We propose a continuous time infinite horizon equilibrium model of financial markets in which arbitrageurs have multiple valuable investment opportunities but face financial constraints. The investment opportunities, heterogeneous along different dimensions, are provided by pairs of similar assets trading at different prices in segmented markets. By exploiting these opportunities, arbitrageurs alleviate the segmentation of markets, providing liquidity to other investors by intermediating their trades. We characterize the arbitrageurs’ optimal investment policy, and derive implications for market liquidity and asset prices.

Keywords

Financial constraints; arbitrage; liquidity; contagion;