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research article

Asset pricing with arbitrage activity

Hugonnier, Julien  
•
Prieto, Rodolfo
2015
Journal of Financial Economics

We study an economy populated by three groups of myopic agents: constrained agents subject to a portfolio constraint that limits their risk taking, unconstrained agents subject to a standard nonnegative wealth constraint, and arbitrageurs with access to a credit facility. Such credit is valuable as it allows arbitrageurs to exploit the limited arbitrage opportunities that emerge endogenously in reaction to the demand imbalance generated by the portfolio constraint The model is solved in closed-form, and we show that, in contrast to existing models with frictions and logarithmic agents, arbitrage activity has an impact on the price level and generates both excess volatility and the leverage effect We show that these results are due to the fact that arbitrageurs amplify fundamental shocks by levering up in good times and deleveraging in bad times. (c) 2014 Elsevier B.V. All rights reserved.

  • Details
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Type
research article
DOI
10.1016/j.jfineco.2014.10.001
Web of Science ID

WOS:000348968200010

Author(s)
Hugonnier, Julien  
Prieto, Rodolfo
Date Issued

2015

Publisher

Elsevier

Published in
Journal of Financial Economics
Volume

115

Issue

2

Start page

411

End page

428

Subjects

Limits of arbitrage

•

Rational bubbles

•

Wealth constraints

•

Excess volatility

•

Leverage effect

Editorial or Peer reviewed

NON-REVIEWED

Written at

EPFL

EPFL units
SFI-JH  
Available on Infoscience
April 21, 2015
Use this identifier to reference this record
https://infoscience.epfl.ch/handle/20.500.14299/113434
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