Risk in Dynamic Arbitrage: Price Effects of Convergence Trading

This paper studies the adverse price effects of convergence trading. I assume two assets with identical cash flows traded in segmented markets. Initially, there is gap between the prices of the assets, because local traders’ face asymmetric temporary shocks. In the absence of arbitrageurs, the gap remains constant until a random time when the difference across local markets disappears. While arbitrageurs’ activity reduces the price gap, it also generates potential losses: the price gap widens with positive probability at each time instant. With the increase of arbitrage capital on the market, the predictability of the dynamics of the gap decreases, and the arbitrage opportunity turns into a risky speculative bet. In a calibrated example we show that the endogenously created losses alone can explain episodes when arbitrageurs lose most of their capital in a relatively short time.Convergence trading, Limits to arbitrage, Liquidity crisis.

Fund managers, career concerns, and asset price volatility

We propose a model of delegated portfolio management with career concerns. Investors hire fund managers to invest their capital either in risky bonds or in riskless assets. Some managers have superior information on the default probability. Looking at the past performance, investors update beliefs on their managers and make firing decisions. This leads to career concerns which affect investment decisions, generating a positive or negative “reputational premium.” For example, when the default probability is high, the return on the risky bond has to be high to compensate the uninformed managers for the high risk of being fired. As the default probability changes over time, the reputational premium amplifies price volatility.Asset pricing

The impact of the global financial crisis on output performance across the European Union: vulnerability and resilience.

This paper uses regression analyses to explain the different output performance in the 27 countries in the EU based on measures of their pre-existing vulnerability and resilience. Rapid financial deepening and high financial leverage, both domestically and externally, were followed by larger output losses during the crisis. The level of financial depth, on the other hand, did not affect output negatively. A large degree of trade openness was associated with weaker output performance, possibly because of falling export demand during the crisis. Finally, government deficits and debt stocks do not seem have impacted negatively on output. The Baltic States stand out as having much explanatory power in the sample due to their large output losses during the crisis.global financial crisis, contagion, business cycles, GDP

Scaling in Words on Twitter

Scaling properties of language are a useful tool for understanding generative processes in texts. We investigate the scaling relations in citywise Twitter corpora coming from the Metropolitan and Micropolitan Statistical Areas of the United States. We observe a slightly superlinear urban scaling with the city population for the total volume of the tweets and words created in a city. We then find that a certain core vocabulary follows the scaling relationship of that of the bulk text, but most words are sensitive to city size, exhibiting a super- or a sublinear urban scaling. For both regimes we can offer a plausible explanation based on the meaning of the words. We also show that the parameters for Zipf's law and Heaps law differ on Twitter from that of other texts, and that the exponent of Zipf's law changes with city size