Jason Shachat (Durham University), 22nd March 2018, 4:30pm, DUBS

Speaker: Jason Shachat, Durham University 

Title: "Market Friction and the anatomy of an arbitrage" (with Peter Bossaerts and Kuangli Xie)

Date & Time: 22nd of March 2018 (Thursday), 4:30-5:45 pm

Venue:  Newcastle University Business School, room 1.13



Under many models of asset markets persistent arbitrage opportunities only exist when market frictions, such as limited short sales and restricted leverage, constrain traders' capacities to exploit and compete away these opportunities. We show in a series of laboratory markets for a single asset, for which there is a certain fundamental value, eliminating these frictions does not drive out frequent arbitrage opportunities. Baseline experiments forbid short sales and leveraged purchases, and we observe significant arbitrage involving both over- and under-pricing of the asset. When we introduce generous short-sell capacities, arbitrage opportunities are not extinguished but their nature changes. The magnitude and frequency of arbitrages involving over-pricing is reduced, but increase for arbitrages involving under-pricing. When we introduce generous capacities for leveraged purchases, the frequency of under-pricing arbitrage decreases while that of the over-pricing increases. Surprisingly, when we introduce both generous short-sale and leveraged purchase facilities the presence and nature of arbitrage opportunities returns to the baseline levels. We also discover arbitrage opportunities are greatly reduced when we increase the market capitalization of the baseline by either increasing the number of market participants by 150%, or by increasing each trader's endowment by 150%. This study provides evidence that arbitrage opportunities are greatly reduced, and correspondingly asset markets are more price efficient, not by relaxing market frictions but rather by increasing capitalization while maintaining frictions.

Last modified: Mon, 19 Mar 2018 13:59:37 GMT