Equilibrium Pricing in Decentralized Markets: The Case of the Equity Lending Market
Abstract: A central tenant to Efficient Market Theory is that arbitrage may be engaged in without cost. Research has shown that, in reality, equity markets are subject to numerous imperfections, one of which is short sale constraints. A primary constraint to arbitrage stems from the decentralized nature of the equity lending market. This paper models interaction in this decentralized marketplace. I conclude, based on the model, that regulators should specifically aim to decrease search costs associated with locating lendable shares of stocks with concentrated institutional ownership.
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