Arbitrage Inefficiency and Regulation in Multi-Stage Market Games

The paper attempts to provide a foundation for the arbitrage inefficiency that emerges in intertemporal financial economies, using as an analytical framework the multi-stage market games. This framework permit us to emphasize the role of the coordination of individuals for administering efficiently the arbitrage opportunities that arise at stage level. When individuals act “myopically” it gives rise to a “coordination failure”. Asset prices are upward pressured and speculative bubbles form regularly. In effort to address adequately the market failure, it is imperative to impose a regulatory scheme that will make the coordination of individuals enforced. Various regulatory schemes are then examined. For the finite-horizon multi-stage market game, coordination is dictated by a bonding scheme while in the infinite-horizon coordination it arises as a self-enforcing strategy.