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Does Arbitrage Flatten Demand Curves for Stocks?

2000; RELX Group (Netherlands); Linguagem: Inglês

10.2139/ssrn.235182

1556-5068

Jeffrey Wurgler, Ekaterina Zhuravskaya,

Monetary Policy and Economic Impact

In textbook theory, demand curves for stocks are kept flat by riskless arbitrage between perfect substitutes. In reality, however, individual stocks do not have perfect substitutes. The risk inherent in arbitrage between imperfect substitutes may deter risk-averse arbitrageurs from flattening demand curves. Consistent with this suggestion and a simple model of demand curves for stocks, we find that stocks without close substitutes experience differentially higher price jumps upon inclusion into the S&P 500 Index. We conjecture that arbitrage forces are weakest, and other pricing anomalies are severest, among stocks without close substitutes (which include small stocks).