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Unformatted text preview: no arbitrage opportunity in this case until
the prices diverge by more than $5, the amount of the
In general, we need to modify our previous conclusions about prices and values by appending the phrase
“up to transactions costs.” In this example, there is only
one competitive price for gold—up to a discrepancy of
the $5 transactions cost.
Fortunately, for most financial markets, these costs
are small. For example, on the TSX, many actively
traded stocks have bid-ask spreads of only between
1 and 10 cents per share. Less actively traded shares
(such as those on the TSX Venture Exchange), though,
do have larger spreads—this can be thought of as
a less liquid or less competitive market. As a first
approximation, we can ignore these spreads in our
analysis. Only in situations in which the NPV is small
(relative to the transactions costs) will any discrepancy
matter. In that case, we will need to carefully account
for all transaction costs to decide whether the NPV is
positive or negativ...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at University of Arizona- Tucson.
- Spring '07