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RFS Advance Access originally published online on June 15, 2008
Review of Financial Studies 2009 22(8):2941-2971; doi:10.1093/rfs/hhn061
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Strategic Financial Innovation in Segmented Markets

Rohit Rahi
London School of Economics, UK

Jean-Pierre Zigrand
London School of Economics, UK

Send correspondence to Rohit Rahi, A351, Department of Finance, London School of Economics, Houghton Street, London WC2A 2AE, UK; telephone: 44 (0)20-7955-7313; fax: 44 (0)20-7955-7420; e-mail: r.rahi{at}lse.ac.uk

JEL Classification: D52, G12


  Abstract

We study an equilibrium model with restricted investor participation in which strategic arbitrageurs reap profits by exploiting mispricings across different market segments. We endogenize the asset structure as the outcome of a security design game played by the arbitrageurs. The equilibrium asset structure depends realistically upon considerations such as depth and gains from trade. It is neither complete nor socially optimal in general; the degree of inefficiency depends upon the heterogeneity of investors.

This paper has benefited from comments by Antoine Faure-Grimaud, Pete Kyle, Joel Peress, and especially Dimitri Vayanos. We also thank seminar participants at University of California, Berkeley, Cambridge, London Business School, Maastricht, Oxford, Stockholm School of Economics, the European Finance Association Meetings, and the NBER/NSF General Equilibrium conference at University of California, Davis.


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