Limits to Arbitrage

In: Business and Management

Submitted By gaines80
Words 1573
Pages 7
Limits to Arbitrage:

Saint Leo University- Chesapeake, Virginia
Corporate Finance: MBA 570
Professor Smith
April 23, 2014


Arbitrage is the idea of buying asset which involves no negative cash flow and making a profit with little or no risk. Understanding arbitrage opportunities is not the only ingredient needed to make sharp predictions. The level of irrationality need to be specified by behavior finance researchers. This is related to how they deviate from the Subjective Expected Utility theory. In order to specify the type of irrationality, researchers have turned to experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and on the people’s preferences, given their beliefs or on how they make decisions, Thaler and Barberis (2002). In this paper, we will concentrate on the extensive literature on the Limits to Arbitrage and explain how the theory was conceived, how it evolved over time and apply a scenario to better explain the research.

Limits to Arbitrage
Understanding arbitrage opportunities is not the only ingredient needed to make sharp predictions. The level of irrationality need to be specified by behavior finance researchers.This is related to how they deviate from the Subjective Expected Utility theory. In order to specify the type of irrationality, researchers have turned to experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and on the people’s preferences, given their beliefs or on how they make decisions, Thaler and Barberis (2002). In this paper, we will concentrate on the extensive literature on the Limits to Arbitrage and explain how the theory was conceived, how it evolved over time and apply a scenario to better explain the research.
Section one Theory
In order to examine the limits of arbitrage one must define…...

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