Arbitraging Arbitrageurs

  1. MUKARRAM ATTARI,
  2. ANTONIO S. MELLO,
  3. MARTIN E. RUCKES*

Article first published online: 16 SEP 2005

DOI: 10.1111/j.1540-6261.2005.00805.x

Issue

The Journal of Finance

The Journal of Finance

Volume 60, Issue 5, pages 2471–2511, October 2005

Additional Information

How to Cite

ATTARI, M., MELLO, A. S. and RUCKES, M. E. (2005), Arbitraging Arbitrageurs. The Journal of Finance, 60: 2471–2511. doi: 10.1111/j.1540-6261.2005.00805.x

Author Information

* *Attari is at Charles River Associates, Mello and Ruckes are at the School of Business, University of Wisconsin-Madison. We thank Markus Brunnermeier, Dimitri Vayanos, participants at the Yale-Nasdaq-JFM Market Microstructure Conference, the 2003 European Finance Association Meeting, the 2004 Econometric Society Winter Meeting, and seminar participants at the University of Chicago, McGill University, the University of Minnesota-Twin Cities, New York University, Tulane University, and the University of Wisconsin-Madison for helpful comments.

Publication History

  1. Issue published online: 16 SEP 2005
  2. Article first published online: 16 SEP 2005

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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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