A Study of Financial Market Frictions and Their Impacts on Financial Intermediaries and the Macroeconomy

本研究探讨了阻碍充分套利活动并可能导致金融市场脆弱性和严重危机的市场摩擦。套利指的是利用错误定价机会的做法，这是由理性和成熟的投资者进行的，例如对冲基金。有效套利确保了金融市场基础设施的高效和运转良好，这对英国经济和生产力至关重要。然而，由于基金经理面临的风险管理、费用结构和资金约束等市场摩擦，套利受到限制，错误定价持续存在，更严重的可能引发金融危机。对套利限制的广泛研究主要集中在错误定价的大小上，但许多问题和限制尚未解决：(1)各种套利摩擦对市场效率的综合影响是什么；（二）在一定时期限制套利的主要摩擦是什么；（iii）是否有可能从数据中识别潜在的市场脆弱性。回答这些问题对于政策制定者（如英格兰银行）在监督和规范金融市场基础设施以确保英国经济平稳运行和制定适当的货币政策以影响经济活动方面至关重要。为了与快速发展的金融市场和对适当监管的巨大需求保持一致，了解套利限制背后的原因需要更多的市场动态知识。为了解决这些问题，本研究进行了理论研究和实证应用，分析了限制套利的两种不同的市场摩擦：成本/风险管理和资金（il）流动性。过高的套利成本使得套利者不愿意进行套利，而资金流动性不足则降低了他们筹集足够资金进行套利的能力。在某些条件下，严重的资金流动性不足会触发放大机制，该机制描述了一个温和事件如何在整个金融体系中传播为大规模溢出效应。在理论方面，本研究提出通过纠正错误定价的套利活动来研究市场摩擦。首先，它揭示了市场摩擦对套利活动和资产定价动态的综合影响，这为确定两者的主导摩擦提供了一种新的方法，更重要的是，它可以衡量市场中资金非流动性的水平并发出放大的信号。通过对美国市场的实证应用，研究结果表明，在近年来的重大金融危机事件中，资金流动性不足占主导地位，存在放大效应，为金融市场基础设施潜在故障提供预警信号，指导政策决策的方向和时机。在整个研究期间，将努力进一步加强这项研究：与现实生活中的套利者（例如对冲基金）进行咨询，以了解市场摩擦如何影响他们的活动以及他们如何克服这些摩擦；与政策制定者和监管机构（如英格兰银行）沟通，了解他们对市场摩擦的看法，并确定需要的信息。还将努力通过会议介绍、期刊出版、建立网络、研究访问、社会媒体报道和在网页上公布报告等方式向潜在用户和受益者传播这项研究的结果。

This research looks into the market frictions that prevent sufficient arbitrage activity and could possibly lead to financial market fragility and severe crisis. Arbitrage refers to the practice of exploiting mispricing opportunities, which is conducted by rational and sophisticated investors, e.g. hedge funds. Effective arbitrage ensures that the financial market infrastructure is efficient and well-functioning, which is critical to the UK economy and productivity. However, due to several market frictions such as risk management, fee structure and funding constraint faced by fund managers, arbitrage is limited, mispricings persist, and more severely financial crises can be triggered. Extensive research on limits to arbitrage have been carried out with focus on the size of mispricing, but many questions and limitations are unsolved: (i) what is the combined impact of various arbitrage frictions on market efficiency; (ii) what is the dominating friction that limits arbitrage at a certain period; (iii) whether it is possible to identify the potential market vulnerability from data. Answering these questions is crucial to the policy-makers, e.g. Bank of England, in supervising and regulating the financial market infrastructures to ensure a smooth functioning of the UK economy and making appropriate monetary policy to influence activities in the economy. In keeping with the fast-developing financial market and the vast demand for appropriate supervision, understanding of what lies behind the limits to arbitrage requires more knowledge of market dynamics. To address these issues, this research conducts theoretical studies and empirical applications to analyze the two distinct market frictions that limit arbitrage: cost/risk management and funding (il)liquidity. Large arbitrage costs render arbitrageurs unwilling to conduct arbitrage, while funding illiquidity reduces their ability to raise sufficient funds to conduct arbitrage. Under certain conditions, severe funding illiquidity triggers the amplification machanism that describes how a moderate event can propagate into a large spillover across the financial system. From the theoretical aspect, the research proposes to investigate market frictions via the arbitrage activity implemented to correct mispricing. First, it reveals the combined effect of the market frictions on the arbitrage activity and asset pricing dynamics, which offers an novel approach to identify the dominating friction of the two, and more importantly, to measure the level of funding illiquidity in the market and signal the occurrence of amplification. By the empirical application in the US market, the results demonstrate the dominance of funding illiquidity and the existence of amplification effect during the major financial crises events in recent years, which provides an early warning signal of potential failure in financial market infrastructure and guides the direction and timing of the policy decision.Throughout this fellowship, efforts will be made to further enhance this research: consulting with real life arbitrageurs, e.g. hedge funds, to understand how market frictions tend to affect their activity and how they overcome these frictions; communicating with policy-makers and regulators, e.g. Bank of England, to understand their opinions on market frictions and identify the information in need. Efforts will also be made to disseminate the finding of this research to potential users and beneficiaries through conference presentation, journal publication, networking, research visit, social media coverage and report disclosed in web page.