Advertising Arbitrage

Speculators often advertise arbitrage opportunities in order to persuade other investors and thus accelerate the correction of mispricing. This induces under-diversification: a risk-averse arbitrageur will optimally advertise only one of several mispriced assets, and overweigh it in his portfolio; a risk-neutral arbitrageur will invest only in this asset. The choice of the asset to be advertised depends not only on its mispricing, but also on its “advertisability” and the precision of future news about it. Prices react more to advertising by arbitrageurs with a successful track record, and reputation building induces high-skill arbitrageurs to advertise more than low-skill ones. Strategic complementarity induces arbitrageurs to invest in the same asset and advertise it. This choice may be inefficient, in the sense that arbitrageurs might collectively benefit by investing in another asset.