DP4176 Strategic Financial Innovation in Segmented Markets

Author(s): Rohit Rahi, Jean-Pierre Zigrand
Publication Date: January 2004
Keyword(s): arbitrage, asset innovation, innovation games, restricted participation
JEL(s): D81, G18, G20
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4176

We analyse an equilibrium model with restricted investor participation in which strategic arbitrageurs play an innovation game and exploit the resulting mispricings by reaping trading profits. Since the equilibrium asset structure is not chosen by a social planner, it is chosen to maximize arbitrage profits and depends therefore realistically upon considerations such as depth, liquidity and gains from trade. In addition, the welfare properties of the resulting asset structure are studied. It is shown that the degree of inefficiency depends upon the heterogeneity of investors. The conjecture of the optimality of ?Macro Markets? is analysed formally in this framework.