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

Dow, J, Han, J and Sangiorgi, F (2021) Hysteresis in price efficiency and the economics of slow-moving capital. Review of Financial Studies, 34 (6). pp. 2857-2909. ISSN 0893-9454 OPEN ACCESS


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.

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Item Type: Article
Subject Areas: Finance
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This is a pre-copyedited, author-produced version of an article accepted for publication in The Review of Financial Studies following peer review. The version of record: 'Hysteresis in Price Efficiency and the Economics of Slow-Moving Capital' -
James Dow, Jungsuk Han, Francesco Sangiorgi
The Review of Financial Studies, hhaa110, is available online at: https://academic.oup.com/rfs/advance-article/doi/10.1093/rfs/hhaa110/5910559 and https://doi.org/10.1093/rfs/hhaa110

Date Deposited: 18 Dec 2020 17:45
Date of first compliant deposit: 11 Jan 2021
Subjects: Asset valuation
Insider trading
Last Modified: 27 May 2024 01:27
URI: https://lbsresearch.london.edu/id/eprint/1599

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