From this point of view, arbitrage is the key force to support the effectiveness of the market, however, its role can not be fully realized in the real financial market. Its limitations are summarized as follows:
1. Some futures contracts do not have exactly the same or very similar substitutes.
Whether we can find a substitute that is exactly the same as or similar to a given security is the key to the effectiveness of arbitrage. If there is such a substitute, we can get the established cash flow in different situations through various methods. Only by finding similar substitutes can arbitrageurs sell high and suck low, correct the price deviation and return the market to an effective state. Arbitrators can't do this if they can't find similar substitutes.
Almost all the subject goods of the same variety in different delivery months can be replaced. Therefore, it plays a better role in intertemporal arbitrage, and the price deviation between contracts in different delivery months is easier to be corrected by arbitrage. The effect of cross-commodity arbitrage and cross-market arbitrage is slightly weak, because the two legs of arbitrage positions can not completely replace each other, such as copper and aluminum in Shanghai Futures Exchange, soybeans in CBOT and soybeans in Dalian Commodity Exchange. In this way, it is impossible to cash out the locked arbitrage profit by directly transferring goods, and only close the position to hedge. Once the arbitrage power is insufficient, the price deviation will be further distorted, which will make the arbitrageurs suffer losses and sometimes even have to stop. Therefore, cross-commodity arbitrage and cross-market arbitrage are generally more risky than intertemporal arbitrage, and of course the potential profits are also great.
2. Noise trader risk
In the noise trading model, investors are divided into two categories: rational arbitrageurs and noise traders. The former has complete basic information, while the latter trades according to noise information irrelevant to the basic value. Noise traders are often overly optimistic because of the rise in securities prices, thus further pushing up prices; Similarly, they will be too pessimistic because of the decline in securities prices, thus further suppressing prices. This kind of risk that further deviates from the normal state due to the change of noise trader's mentality is called noise trader risk.
Any short-term arbitrageur must bear this risk. The risk of noise traders will lead to the behavior variation of rational arbitrageurs. They may "rationally" ignore the analysis of basic information and turn to predict the behavior of noise traders, so that the operation direction is consistent with that of noise traders, thus accelerating the price rise and fall. In this sense, rational arbitrageurs are transformed into noise traders to some extent, which increases the fluctuation of securities prices and weakens market efficiency. This behavior tendency of arbitrageurs is the main reason for the finiteness of arbitrage.
3. Time span of arbitrage
The time span of arbitrage is an important factor that arbitrageurs need to consider. In the short term, there is a risk that the price deviation will be further distorted. For short-term arbitrageurs, this risk is the most important when their counterparties are noise traders, because before the noise traders' mentality returns to normal level, they may go further to extremes. Most arbitrageurs don't manage their own funds, they are just agents of investors. Usually, investors evaluate arbitrageurs by watching their performance in a relatively short period of time, and then pay them according to their work performance.
If the price deviation lasts longer than the time to evaluate the arbitrageurs, the income of the arbitrageurs will not increase, and if the price deviation is further distorted, their income will decrease. Moreover, because most arbitrageurs will raise money from financial institutions or individual investors during arbitrage, they must pay interest. If the price is further unfavorable to arbitrageurs, with the increase of floating losses, the risk of liquidation will also follow. This risk will also reduce the risk tolerance of arbitrageurs to noise traders.
4. Empty risk
Arbitrage inevitably involves going long and shorting at the same time. In the futures market, sometimes there may be short positions. No matter what kind of arbitrage, if the short contract is short, the arbitrage position is often a loss. When the short-selling behavior is not terminated, the price deviation will be distorted to an unimaginable extent. In many emerging markets, the fear of short-selling risk has become the biggest obstacle to arbitrage because of the inability to grasp the fundamental changes in time.
5. Transaction costs
Transaction cost is another important factor that arbitrageurs need to consider. In futures arbitrage, the transaction cost includes the handling fee for buying and selling futures contracts, and if it involves physical delivery, it also needs to pay the delivery fee.
In addition, if illiquid contracts are bought and sold, the related costs paid for the larger bid-ask spread may be very large, and the restrictions on arbitrageurs are also very obvious. Sometimes the transaction cost will be high, even if the arbitrage is successful, the transaction cost will account for a considerable proportion of the arbitrage profit, such as the intertemporal arbitrage of Shanghai Copper.