Bank-Intermediated Arbitrage

Boyarchenko, Nina; Eisenbach, Thomas M.; Gupta, Pooja; Shachar, Or; Van Tassel, Peter

Discussion Paper

Bank-Intermediated Arbitrage

Abstract: Since the 2007-09 financial crisis, the prices of closely related assets have shown persistent deviations—so-called basis spreads. Because such disparities create apparent profit opportunities, the question arises of why they are not arbitraged away. In a recent Staff Report, we argue that post-crisis changes to regulation and market structure have increased the costs to banks of participating in spread-narrowing trades, creating limits to arbitrage. In addition, although one might expect hedge funds to act as arbitrageurs, we find evidence that post-crisis regulation affects not only the targeted banks but also spills over to less regulated firms that rely on bank intermediation for their arbitrage strategies.

Keywords: bank regulation; hedge funds; arbitrage;

JEL Classification: G1;