We propose a multiperiod model in which competitive arbitrageurs exploit discrepancies between the prices of two identical risky assets traded in segmented markets. Arbitrageurs need to collateralize separately their positions in each asset, and this implies a financial constraint limiting positions as a function of wealth. In our model, arbitrage activity benefits all investors because arbitrageurs supply liquidity to the market. However, arbitrageurs might fail to take a socially optimal level of risk, in the sense that a change in their positions can make all investors better off. We characterize conditions under which arbitrageurs take too much or too little risk.

This is an electronic version of an Article published in the Quarterly journal of economics, 118 (3). AbstractWe propose a boundedly-rational model of opinion formation in which individuals are subject to persuasion bias; that is, they fail to account for possible repetition in the information they receive. We show that persuasion bias implies the phenomenon of social influence, whereby one's influence on group opinions depends not only on accuracy, but also on how well-connected one is in the social network that determines communication. Persuasion bias also implies the phenomenon of unidimensional opinions; that is, individuals' opinions over a multidimensional set of issues converge to a single "left-right" spectrum. We explore the implications of our model in several natural settings, including political science and marketing, and we obtain a number of novel empirical implications. * DeMarzo and Zwiebel: Graduate School of Business, Stanford University, Stanford CA 94305, Vayanos: MIT Sloan School of Management, 50 Memorial Drive E52-437, Cambridge MA 02142. This paper is an extensive revision of our paper, "A Model of Persuasion -With Implication for Financial Markets," (first draft, May 1997). We are grateful to Nick Barberis, Gary Becker, Jonathan Bendor, Larry Blume, Simon Board, Eddie Dekel, Stefano DellaVigna, Darrell Duffie, David Easley, Glenn Ellison, Simon Gervais, Ed Glaeser, Ken Judd, David Kreps, Edward Lazear, George Loewenstein, Lee Nelson, Anthony Neuberger, Matthew Rabin, José Scheinkman, Antoinette Schoar, Peter Sorenson, Pietro Veronesi, Richard Zeckhauser, three anonymous referees, and seminar participants at the American Finance Association Annual Meetings, Boston University, Cornell, Carnegie-Mellon, ESSEC, the European Summer Symposium in Financial Markets at Gerzensee, HEC, the Hoover Institution, Insead, MIT, the NBER Asset Pricing Conference, the Northwestern Theory Summer Workshop, NYU, the Stanford Institute for Theoretical Economics, Stanford, Texas A&M, UCLA, U.C. Berkeley, Université Libre de Bruxelles, University of Michigan, University of Texas at Austin, University of Tilburg, and the Utah Winter Finance Conference for helpful comments and discussions. All errors are our own. I IntroductionIn this paper, we propose a model of opinion formation in which individuals are subject to persuasion bias, failing to adjust properly for possible repetitions of information they receive. We argue that persuasion bias provides a simple explanation for several important phenomena that are otherwise hard to rationalize, such as propaganda, censorship, marketing, and the importance of air-time. We show that persuasion bias implies two additional phenomena. First, that of social influence, whereby one's influence on group opinions depends not only on accuracy, but also on how well-connected one is in the social network according to which communication takes place. Second, that of unidimensional opinions, whereby individuals' opinions over a multidimensional set of issues can be represented by...

We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles' demand for bonds affect the term structureand constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.

We examine empirically how the supply and maturity structure of government debt affect bond yields and expected returns. We organize our investigation around a term-structure model in which risk-averse arbitrageurs absorb shocks to the demand and supply for bonds of different maturities. These shocks affect the term structure because they alter the price of duration risk.Consistent with the model, we find that the maturity-weighted-debt-to-GDP ratio is positively related to bond yields and future returns, controlling for the short rate. Moreover, these effects are stronger for longer-maturity bonds and following periods when arbitrageurs have lost money.We use our empirical estimates to calibrate the model. * We thank Malcolm Baker, Dan Bergstresser, Kobi Boudoukh, Mike Chernov, Greg Duffee, Mike Fleming, Ken Froot, Ken Garbade, Sam Hanson, Frank Keane, Arvind Krishnamurthy, Dina Marchioni, Jonathan Parker, Anna Pavlova, Christopher Polk, Andrei Shleifer, Erik Stafford, Jeremy Stein, Otto Van Hemert, Jaume Ventura, Pietro Veronesi, Jean-Luc Vila, Annette Vissing-Jorgensen, Jeff Wurgler, an anonymous referee, and seminar participants at BGI, Bank of England, Chicago Fed, CREI Pompeu Fabra, Duke, Harvard, Hebrew U., LSE, New York Fed, Northwestern, Tel-Aviv, Yale, and the Chicago "Beyond Liquidity" conference for helpful comments. We are especially grateful to John Cochrane for an extensive set of insightful comments. Sonya Lai provided excellent research assistance. Financial support from the Division of Research at the HBS and the Paul Woolley Centre at the LSE is gratefully acknowledged.

We propose a dynamic equilibrium model of a multi-asset market with stochastic volatility and transaction costs. Our key assumption is that investors are fund managers, subject to withdrawals when fund performance falls below a threshold. This generates a preference for liquidity that is timevarying and increasing with volatility. We show that during volatile times, assets' liquidity premia increase, investors become more risk averse, assets become more negatively correlated with volatility, assets' pairwise correlations can increase, and illiquid assets' market betas increase.Moreover, an unconditional CAPM can understate the risk of illiquid assets because these assets become riskier when investors are the most risk averse.