Risk and Arbitrage

Authored by: Carolyn Hardin , Adam Richard Rottinghaus

The Routledge Handbook of Critical Finance Studies

Print publication date:  September  2020
Online publication date:  September  2020

Print ISBN: 9781138079816
eBook ISBN: 9781315114255
Adobe ISBN:

10.4324/9781315114255-7

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Abstract

Arbitrage—the financial trading strategy in which securities are bought at a high price and sold at a lower price to profit from differences in price across markets or time—is central to financial theory. Mainstream financial economics and some critical work on finance assumes that arbitrage serves to bring prices into parity and eliminates inefficiency. Similarly, financial risk is often taken for granted as objective measure of uncertainty. In this chapter, we trace the current financial economic understanding of arbitrage in relation to the “Law of One Price,” and show that arbitrage is not a fleeting or abnormal form of financial trading but a central form of financial profit making. We then offer a genealogy of risk in financial and critical theory and explain how its objectivity is constructed and taken for granted. Finally, in a case study about arbitrage in collateralized debt obligations before the financial crisis, we demonstrate that collective affirmation of the objectivity of risk, as represented in the prices of credit default swaps, is what made that arbitrage possible.

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