Arbitrage and Its Physical Limits

We extend the Limits to Arbitrage literature by studying how physical constraints affect financial arbitrage in commodity markets. Using the U.S. crude oil market as our experimental setting, we document substantial economically significant violations of the no-arbitrage futures pricing conditions due to storage capacity constraints at the WTI futures delivery hub. We also find evidence of financial constraints. Our findings are robust to different measures of physical constraints, and controls for potential effects of U.S. Oil Fund rolls. Our results highlight the importance of both physical and financial arbitrage limits in pricing commodity futures. We also contribute to the Theory of Storage literature, which has largely ignored storage limits, by documenting the effects of finite storage capacity