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Hysteresis in price efficiency and the economics of slow-moving capital

Journal

Review of Financial Studies

Subject

Finance

Publishing details

Review of Financial Studies 2021 Vol 34:6 p 2857-2909

Authors / Editors

Dow J;Han J;Sangiorgi F

Biographies

James Dow

Publication Year

2021

Abstract

Will arbitrage capital flow into markets experiencing shocks, mitigating adverse effects on price efficiency? Not necessarily. In a dynamic model with privately informed capital-constrained arbitrageurs, price efficiency plays a dual role, determining both the profitability of new arbitrage and the ability to close existing positions profitably. An adverse shock to efficiency lengthens arbitrage duration, effectively reducing the amount of arbitrage capital available for new positions. If this falls below a critical mass, arbitrage capital flows out, amplifying the impact on price efficiency. This creates endogenous regimes: temporary shocks can trigger “hysteresis,” a persistent shift in price efficiency.

Keywords

Asymmetric and private information; Mechanism design; Search; Learning; Information and knowledge; Communication; Belief; Unawareness; Expectations; Speculations; Asset pricing; Trading volume; Bond interest rates; Information and market efficiency

Available on ECCH

No


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