Work

Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market

Year: 2005

Type: report

Abstract: Limits of Arbitrage" theories hypothesize that the marginal investor in a particular asset market is a specialized arbitrageur rather than a diversified representative investor.We examine the mortgagebacked securities (MBS) market in this light.We show that the risk of homeowner prepayment, which is a wash in the aggregate, is priced in the MBS market.The covariance of prepayment risk with aggregate wealth implies the wrong sign to match the observed prices of prepayment risk.The price of risk is better explained by a kernel based on MBS-market-wide specific risk.This finding is consistent with the specialized arbitrageur hypothesis.

Source: National Bureau of Economic Research

DOI: 10.3386/w11851

Authors: Xavier Gabaix, Arvind Krishnamurthy, Olivier Vigneron

Institutions: National Bureau of Economic Research, Massachusetts Institute of Technology, HEC Montréal, Northwestern University, University of British Columbia, University of Chicago, University of California, Berkeley

Language: English

Topic: Financial Markets and Investment Strategies

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

OpenAlex ID: W2890770196

Cites: 36

Cited by: 28

Related to: 10