ABSTRACT This paper uses a nonlinear arbitrage‐pricing model, a conditional linear model, and an unconditional linear model to price international equities, bonds, and forward currency contracts. Unlike linear models, the nonlinear arbitrage‐pricing model requires no restrictions on the payoff space, allowing it to price payoffs of options, forward contracts, and other derivative securities. Only the nonlinear arbitrage‐pricing model does an adequate job of explaining the time series behavior of a cross section of international returns.

ABSTRACT We describe how episodic illiquidity arises from a breakdown in cooperation between market participants. We first solve a one‐period trading game in continuous‐time, using an asset pricing equation that accounts for the price impact of trading. Then, in a multi‐period framework, we describe an equilibrium in which traders cooperate most of the time through repeated interaction, providing apparent liquidity to one another. Cooperation breaks down when the stakes are high, leading to predatory trading and episodic illiquidity. Equilibrium strategies that involve cooperation across markets lead to less frequent episodic illiquidity, but cause contagion when cooperation breaks down.