Long capital lockups exist because arbitrage spreads can widen before converging

Evidence

LTCM had known perfectly well that a flight to quality could happen and that this would be its consequence. Indeed, it was of the very essence of convergence and relative-value arbitrage that spreads could widen relative prices could move against the arbitrageur before a trade finally converged. For that reason, LTCM had required investors to leave their capital in the fund for a minimum of three years: it was in part this restriction that made the fund LongTerm Capital Management. — Donald MacKenzie, An Engine, Not a Camera, 1041

Categorization

• DEFINE: Explains convergence/relative-value arbitrage’s core risk and why LTCM’s three-year lockup existed.
• XREF: connects to: Limited arbitrage capital can force abandonment of even certain-profit trades — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1217; Market microstructure shapes whether arbitrage opportunities persist or vanish — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 94; Sudden margin hikes can trigger forced sales that amplify the very volatility causing them — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 941 (+1 more)

Broader Connections

• Limited arbitrage capital can force abandonment of even certain-profit trades #expands (0.88) — Donald MacKenzie, An Engine, Not a Camera, 1217
• Market microstructure shapes whether arbitrage opportunities persist or vanish #expands (0.82) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 94