Competition Dynamics, Market Depth, and the Speed of Arbitrage

I study how sequential entry into an arbitrage affects the liquidity of underlying assets and the speed of arbitrage. Incumbent arbitrageurs exploit a mispricing between two identical but imperfectly liquid assets. Because of market thinness, incumbent arbitrageurs trade slowly to limit their price impact. As a result, the arbitrage opportunity does not vanish instantaneously, giving a follower the opportunity to enter the trade upon sinking a fixed cost. Because arbitrageurs' trading counterparties are forward-looking, prices and market depth reflect the expected outcome of the sequential entry game. This feedback loop from the possibility of entry to market depth gives incumbents more incentives to deter, leading to endogenous barriers to entry. If entry does occur in equilibrium, market depth and the speed of arbitrage increase ahead of entry, while they remain unchanged if the follower stays out. Under entry threat, the mispricing increases in the number of incumbents