A Transaction-Level Analysis of Spatial Arbitrage: The Role of Habit, Attention, and Electronic Trading

Abstract

Despite the central role of arbitrage in finance and economic theory, there is limited evidence of the factors that create and eliminate arbitrage opportunities, how often arbitrage occurs, and how profitable it is. We address these gaps via a transaction-level analysis of spatial arbitrage in the wholesale automotive market. We investigate why arbitrage opportunities are created by analyzing how sellers choose where to sell vehicles. We find that the attention sellers pay to the distribution of a vehicle is negatively related to the probability that it is arbitraged. Arbitrage occurs in approximately 1% of transactions, although electronic trading is making arbitrage less prevalent by improving buyer/seller matching across locations. Arbitrage yields a 5.6% return on average, although arbitrageurs take a loss 14% of the time. Our results contribute to the literature on arbitrage, the effect of attention allocation on market outcomes, and the effect of information technology on market efficiency.

Keywords: Limited Attention, Market Speculation, Electronic Trading, Information Technology, Automotive, Spatial Arbitrage, Market Integration