Articlegreen1992

Arbitrage With Holding Costs: A Utility-Based Approach

107 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Stochastic processes and financial applications Economic theories and models

Abstract

ABSTRACT Unit time costs, or holding costs, are incurred in many arbitrage contexts. Examples include losing the use of short sale proceeds and lending funds at below market rates in reverse repurchase agreements. This paper analyzes the investment problem of a risk averse arbitrageur who faces holding costs. The model allows prices to deviate from “fundamental” values without allowing for riskless arbitrage opportunities. After characterizing an arbitrageur's optimal strategy, the model is examined in the context of the Treasury market. The analysis reveals that holding costs are an important friction in this market and that they can significantly affect arbitrageur behavior.

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References

1973An Intertemporal Capital Asset Pricing Model 1990Noise Trader Risk in Financial Markets 1991Investor Sentiment and the Closed-End Fund Puzzle 1991Investor Sentiment and the Closed‐End Fund Puzzle 1989Optimal replication of contingent claims under transaction costs 1990Equilibrium Short Horizons of Investors and Firms 1991Liquidity, Maturity, and the Yields on U.S. Treasury Securities 1991An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs

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