Nonlinear limits to arbitrage

Chen, Jingzhi, Cai, Charlie X ORCID: 0000-0003-1398-3715, Faff, Robert and Shin, Yongcheol (2022) Nonlinear limits to arbitrage. Journal of Futures Markets, 42 (6). pp. 1084-1113.

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Official URL: http://dx.doi.org/10.1002/fut.22320

Abstract

<jats:title>Abstract</jats:title><jats:p>We study the nonlinear limits to arbitrage in a model. When mispricing is small, arbitrage activity increases with mispricing because of the higher cost‐adjusted return. However, at high levels of mispricing, arbitrageurs are deterred by larger mispricing as funding constraints become more binding. Testing the model predictions on the index spot‐futures arbitrage with a Markov‐switching model, we document an inverse U‐shaped relationship between mispricing and arbitrage activity. The extreme regime is with the largest mispricing but least arbitrage activity, and coincides with the market turmoil, suggesting that funding constraints become the main driver behind the limit to arbitrage.</jats:p>

Item Type:	Article
Uncontrolled Keywords:	Limited Arbitrage, Noise Momentum, Futures and Spot Prices, Markov Switching Model
Divisions:	Faculty of Humanities and Social Sciences > School of Management
Depositing User:	Symplectic Admin
Date Deposited:	31 Mar 2022 10:29
Last Modified:	25 Aug 2023 05:04
DOI:	10.1002/fut.22320
Open Access URL:	https://doi.org/10.1002/fut.22320
Related URLs:	Publisher
URI:	https://livrepository.liverpool.ac.uk/id/eprint/3151825