@article{73c9090986814df2bfeb1c4216f01dc5,
title = "Nonlinear limits to arbitrage",
abstract = "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.",
author = "Jingzhi Chen and Cai, {Charlie X.} and Robert Faff and Yongcheol Shin",
note = "Funding Information: We are grateful to Adam Golinski, Minh Nguyen, Tyler Shumway, Andy Snell, Huamao Wang, Tim Worrall and the seminar participants at University of York, University of Edinburgh, University of Kent, the 22nd Spring Meeting of Young Economists, and the 25th Annual Symposium of the Society for Nonlinear Dynamics and Econometrics for their helpful comments. Chen acknowledges financial support from Department of Economics and Related Studies, University of York and the ESRC Postdoctoral Grant (ES/S010238/1). Any errors or omissions are the responsibility of the authors. The usual disclaimer applies. Funding Information: We are grateful to Adam Golinski, Minh Nguyen, Tyler Shumway, Andy Snell, Huamao Wang, Tim Worrall and the seminar participants at University of York, University of Edinburgh, University of Kent, the 22nd Spring Meeting of Young Economists, and the 25th Annual Symposium of the Society for Nonlinear Dynamics and Econometrics for their helpful comments. Chen acknowledges financial support from Department of Economics and Related Studies, University of York and the ESRC Postdoctoral Grant (ES/S010238/1). Any errors or omissions are the responsibility of the authors. The usual disclaimer applies. Publisher Copyright: {\textcopyright} 2022 The Authors. The Journal of Futures Markets published by Wiley Periodicals LLC.",
year = "2022",
month = jun,
doi = "10.1002/fut.22320",
language = "English",
volume = "42",
pages = "1084--1113",
journal = "Journal of Futures Markets",
issn = "0270-7314",
publisher = "Wiley-Academy",
number = "6",
}