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Jiro E. Kondo
PhD Candidate in Financial Economics
*** Job Market Candidate ***
MIT Sloan School of Management
50 Memorial Drive, E52-416
Cambridge, MA 02139
Phone: (617) 324-6709
Fax: (617) 258-6855
jekondo[at]mit[dot]edu
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SECONDARY PAPER:
Financial
Relationships and the Limits to Arbitrage (w/ Dimitris Papanikolaou)
We propose a new foundation for
the limits to arbitrage based on financial relationships between arbitrageurs and
banks. Financially constrained arbitrageurs may choose to seek additional financing
from banks who can understand their strategies. However, a hold-up problem arises
because banks cannot commit to provide capital and have the financial technology to
profit from the strategies themselves. Wary of this, arbitrageurs will choose to
stay constrained and limit their correction of mispricing unless banks have
sufficient reputational capital. Using the framework of stochastic repeated games,
we show that this form of limited arbitrage arises when mispricing is largest and
becomes more substantial as the degree of competition between banks intensifies and
arbitrageur wealth increases.
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