Which of the following statements best describes the effect of transaction costs on arbitrage and the Law of One Price?
A)As long as the market is competitive,transaction costs will have no effect.
B)When there are transaction costs,there will never be arbitrage opportunities.
C)Prices can deviate but not by more than the amount of the transaction costs.
D)Prices will be different in different competitive markets,and this difference usually exceeds the amount of the transaction costs.
E)Arbitrage possibilities increase in the presence of transaction costs.

Question

Quizplus · Accepted Answer

Transaction costs can prevent arbitrageurs from taking advantage of price differences in different markets, and therefore prices can deviate by the amount of the transaction costs. However, if the deviation is greater than the cost of transactions, arbitrageurs will still have an incentive to engage in arbitrage. The Law of One Price still holds, but the opportunity cost of engaging in arbitrage increases with higher transaction costs.

Which of the Following Statements Best Describes the Effect of Transaction