Liquidity

Limits to Arbitrage
What role does market liquidity play in arbitrage opportunities?

Hint

Answer

Market liquidity is crucial for arbitrage opportunities. High liquidity allows arbitrageurs to quickly enter and exit positions, which is essential for capitalizing on short-lived mispricing between assets. Low liquidity can pose a significant barrier, as it may result in higher transaction costs and longer timeframes for executing trades, reducing potential profits. In extreme cases, low liquidity can entirely prevent effective arbitrage, as the inability to execute trades in a timely manner can cause the opportunity to vanish.