Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/83629
Authors: 
Kondor, Péter
Year of Publication: 
2006
Series/Report no.: 
MNB Working Papers 2006/6
Abstract: 
This paper studies the adverse price effects of convergence trading. I assume two assets with identical cash flows traded in segmented markets. Initially, there is gap between the prices of the assets, because local traders’ face asymmetric temporary shocks. In the absence of arbitrageurs, the gap remains constant until a random time when the difference across local markets disappears. While arbitrageurs’ activity reduces the price gap, it also generates potential losses: the price gap widens with positive probability at each time instant. With the increase of arbitrage capital on the market, the predictability of the dynamics of the gap decreases, and the arbitrage opportunity turns into a risky speculative bet. In a calibrated example we show that the endogenously created losses alone can explain episodes when arbitrageurs lose most of their capital in a relatively short time.
Subjects: 
convergence trading
Limits to arbitrage
Liquidity crisis
JEL: 
G10
G20
D5
Document Type: 
Working Paper

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