Universität Bonn

Department of Economics

Eduardo Dávila - Yale University

"The Value of Arbitrage", together with Daniel Graves and Cecilia Parlatore

Abstract

This paper studies the social value of closing price differentials in financial markets. We show that arbitrage gaps (price differentials between markets) exactly correspond to the social marginal value of executing an arbitrage trade. We further show that arbitrage gaps and measures of price impact are sufficient to compute the aggregate total gain from closing an arbitrage gap. Theoretically, we show that, for a given arbitrage gap, the total value of arbitrage is higher in more liquid markets. We apply our framework to compute the welfare gains from closing arbitrage gaps in the context of covered interest parity violations and several dual-listed companies. The range of estimates of the value of closing arbitrage gaps varies across applications.

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