Exploiting arbitrage requires short selling

TL;DR

This paper demonstrates that arbitrage opportunities in semimartingale markets can only be exploited via short selling, highlighting regulatory implications and associated bankruptcy risks.

Contribution

It provides a theoretical foundation showing that short selling is necessary to exploit arbitrage in semimartingale markets, explaining regulatory differences.

Findings

Arbitrage can only be exploited through short selling.

Short selling access introduces bankruptcy risk.

Regulatory distinctions are justified by arbitrage exploitation methods.

Abstract

We show that in a financial market given by semimartingales an arbitrage opportunity, provided it exists, can only be exploited through short selling. This finding provides a theoretical basis for differences in regulation for financial services providers that are allowed to go short and those without short sales. The privilege to be allowed to short sell gives access to potential arbitrage opportunities, which creates by design a bankruptcy risk.