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Strategic financial innovation in segmented markets

By Rohit Rahi and Jean-Pierre Zigrand

Abstract

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

Topics: HG Finance
Publisher: Centre for Economic Policy Research
Year: 2004
OAI identifier: oai:eprints.lse.ac.uk:5374
Provided by: LSE Research Online
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