This paper explores a financial market model where some investors (arbitrageurs) have better investment opportunities than others but face financial constraints. The model consists of a riskless asset and two risky assets with identical payoffs, traded in segmented markets. Arbitrageurs can invest in both assets and exploit price discrepancies, acting as intermediaries that supply liquidity to other investors. The financial constraints limit the positions arbitrageurs can take, requiring them to collateralize their positions separately in each asset. The paper analyzes the implications of these constraints on arbitrageur behavior, asset prices, and welfare. Key findings include: 1. **Equilibrium Analysis**: In the certainty case, arbitrageurs fully absorb supply shocks and close price wedges if their initial wealth is sufficient. If the financial constraint binds, arbitrageurs do not fully absorb supply shocks, leading to a narrowing of the price wedge over time. 2. **Welfare Analysis**: Arbitrage activity benefits all investors by providing liquidity, but arbitrageurs may fail to take a socially optimal level of risk. Specifically, reducing their positions can make all investors better off, while increasing their positions can be Pareto improving. 3. **Pareto Improvement**: The Pareto improvement occurs because a change in arbitrageurs' positions affects prices, and the marginal rates of substitution differ among agents, leading to wealth redistribution. The paper provides insights into the welfare implications of financial constraints and the potential for allocative inefficiency in financial markets. It also highlights the importance of understanding the intertemporal wealth effects and the role of financial constraints in market dynamics.This paper explores a financial market model where some investors (arbitrageurs) have better investment opportunities than others but face financial constraints. The model consists of a riskless asset and two risky assets with identical payoffs, traded in segmented markets. Arbitrageurs can invest in both assets and exploit price discrepancies, acting as intermediaries that supply liquidity to other investors. The financial constraints limit the positions arbitrageurs can take, requiring them to collateralize their positions separately in each asset. The paper analyzes the implications of these constraints on arbitrageur behavior, asset prices, and welfare. Key findings include: 1. **Equilibrium Analysis**: In the certainty case, arbitrageurs fully absorb supply shocks and close price wedges if their initial wealth is sufficient. If the financial constraint binds, arbitrageurs do not fully absorb supply shocks, leading to a narrowing of the price wedge over time. 2. **Welfare Analysis**: Arbitrage activity benefits all investors by providing liquidity, but arbitrageurs may fail to take a socially optimal level of risk. Specifically, reducing their positions can make all investors better off, while increasing their positions can be Pareto improving. 3. **Pareto Improvement**: The Pareto improvement occurs because a change in arbitrageurs' positions affects prices, and the marginal rates of substitution differ among agents, leading to wealth redistribution. The paper provides insights into the welfare implications of financial constraints and the potential for allocative inefficiency in financial markets. It also highlights the importance of understanding the intertemporal wealth effects and the role of financial constraints in market dynamics.