Author(s)

Renao Zhang ¹

Affiliation(s)

¹ Nanjing Foreign Language School, Nanjing, Jiangsu, 210000, China

Corresponding Author

Renao Zhang

ABSTRACT

The continuous failure of Japan's cross-border ETF arbitrage mechanism in multiple market periods is not due to a single institutional obstacle, but rather the failure of the liquidity supply function of market makers as core intermediaries under the triple constraints of risk exposure, capital efficiency, and incentive constraints. Starting from the theoretical framework of arbitrage mechanism, this article systematically analyzes the event evidence and institutional causes of failure, revealing the inherent logic of weakened market makers' quotation motivation, fragile inventory management, lack of hedging tools, and imbalanced incentive constraints. On this basis, four optimization schemes are proposed, including the reconstruction of incentive mechanisms based on dynamic risk compensation, collaborative improvement of cross market settlement and collateral management, integration of exchange rate hedging tools and inventory management processes, and the design of emergency liquidity support and circuit breaker system. Research has shown that by restructuring the system to match market makers' risk-taking with economic incentives, the operation of arbitrage mechanisms can be effectively restored, and market pricing efficiency and resilience can be improved.

KEYWORDS

Cross border ETF; Arbitrage mechanism; Market makers; Liquidity supply

CITE THIS PAPER

Renao Zhang. Operational Failure of Arbitrage Mechanisms and Market Maker Liquidity Supply Optimization for Japan Cross-Border ETFs. Financial Engineering and Risk Management (2026). Vol. 9, No. 1, 41-49. DOI: http://dx.doi.org/10.23977/ferm.2026.090104.

REFERENCES

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[3] Liu, Yingfei, Li, Haofei, and Lin, Wanfa. Exchange Market-Maker System and the High-Quality Development of the Bond Market[J]. Journal of Financial Research, 2025, (7): 188–206.
[4] Li, Wei and Xi, Fengyuan. Market-Making Mechanism and Stock Liquidity: A Quasi-Natural Experiment Based on the STAR Market Reform[J]. The Journal of World Economy, 2025, 48(5): 128–159.
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