Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/223562 
Year of Publication: 
2020
Series/Report no.: 
CESifo Working Paper No. 8490
Publisher: 
Center for Economic Studies and Ifo Institute (CESifo), Munich
Abstract: 
We study a segmented-markets setting in which self-fulfilling volatility can arise. The only requirements are (i) asset price movements redistribute wealth across markets (e.g., equities rise as bonds fall) and (ii) some stabilizing force keeps valuation ratios stationary (e.g., cash flow growth rises when valuations rise). We prove that when self-fulfilling volatility exists, arbitrage opportunities must also exist. Conversely, at times when arbitrage profits exist, asset markets are susceptible to self-fulfilling fluctuations. The tight theoretical connection between price volatility and arbitrage is detectable in currency markets by studying deviations from covered interest parity.
Subjects: 
limits to arbitrage
segmented markets
volatility
self-fulfilling prices
multiple equilibria
covered interest parity
JEL: 
D84
G11
G12
Document Type: 
Working Paper
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