Arbitrage crashes and the speed of capital

The imminent failure of prime brokers during the 2008 financial crisis caused a sudden decrease in the leverage afforded hedge funds. This decrease resulted from the asymmetrical payoff to rehypothecation lenders-the ultimate financiers, through prime brokers, to hedge funds. Seemingly long-term debt capital became short-term capital creating a duration mismatch between left-hand side arbitrage opportunities and right-hand side liabilities. Consequently, arbitrageurs became unable to maintain similar prices of similar assets. Mispricing magnitudes, and the time required to correct them, reflect the role of arbitrageurs in maintaining accurate prices during normal times and offer an estimate of discounts at which assets transact during crises. (C) 2011 Elsevier B.V. All rights reserved.