Articlebronze2005

Arbitraging Arbitrageurs

Mukarram Attari · António S. Mello · Martin E. Ruckes

68 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 This paper develops a theory of strategic trading in markets with large arbitrageurs. If arbitrageurs are not well capitalized, capital constraints make their trades predictable. Other market participants can exploit this by trading against them. Competitors may find it optimal to lend to arbitrageurs that are financially fragile; additional capital makes the arbitrageurs more viable, and lenders can reap profits from trading against them for a longer time. The strategic behavior of these market participants has implications for the functioning of financial markets. Strategic trading may produce significant price distortions, increase price manipulation, and trigger forced liquidations of large traders.

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References

1995The Limits of Arbitrage 1990Positive Feedback Investment Strategies and Destabilizing Rational Speculation 1990A Theory of Predation Based on Agency Problems in Financial Contracting 2001When genius failed: the rise and fall of Long-Term Capital Management 1992Stock-Price Manipulation 2005Predatory Trading 2003Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities 2001Convergence trading with wealth effects: an amplification mechanism in financial markets

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