Arbitrage Funnel Theory

Working Paper · v1.0 · 2026

A neutral, structural model of how extractability drives wealth divergence

Arbitrage Funnel Theory proposes that modern markets don’t just grow — they pull capital out of wages, small businesses, and non‑securitized domains into highly extractable, arbitrageable structures that drift upward over time.

Conceptual working paper Asset pricing · Microstructure · Flows

~15 minute read · Working paper v1.0 · Author: Matthew Butcher

Arbitrage Funnel Theory (AFT) is a structural framework for understanding why modern financial markets exhibit a persistent upward drift relative to the real economy. The core claim is simple:

Capital structurally migrates from low‑extractability domains (wages, small businesses, non‑securitized assets) into high‑extractability, arbitrageable markets (public equities, derivatives, liquid credit), where it can be hedged, levered, securitized, and harvested.

Once inside these markets, capital interacts with passive flows, leverage, corporate buybacks, and retail behavior to generate a self‑reinforcing drift that traditional equilibrium stories don’t fully explain.

Why it matters

For markets

AFT reframes “markets go up over time” as a structural outcome of extractability, not just growth or productivity. It provides a language for thinking about:

• Why securitized assets outpace non‑securitized wealth.
• Why crises unwind violently when arbitrage capital is constrained.
• How liquidity regimes shape long‑term price levels.

For individuals

If you live in low‑extractability domains (wages, small businesses, local services), you are structurally on the wrong side of the funnel. AFT helps explain:

• Why wages lag asset prices.
• Why homeownership feels like it’s “falling behind” financial assets.
• Why retail investors often supply volatility and exit liquidity, not durable edge.

For researchers and policymakers

AFT connects financialization, inequality, and market microstructure under a single mechanism: the extractability gradient. It suggests that:

• Regulation of leverage and derivatives reshapes the funnel itself.
• Financialization is not a side effect; it is a structural attractor.

Inside the paper

The working paper walks through the theory step by step:

• Abstract: High‑level overview and motivation.
• Introduction: Why existing explanations for market drift are incomplete.
• Background: Limits to arbitrage, arbitrage capital, passive flows, financialization.
• Core Definitions: Arbitrageable vs non‑arbitrageable assets, extractability, arbitrage capital, the capital funnel.
• Mechanism: How capital moves along the extractability gradient and why that matters.
• Formal Model: A stylized representation of the funnel and its impact on price drift.
• Predictions: Testable hypotheses around flows, funding stress, and wealth distribution.
• Implications: Markets, individuals, and policy in a world governed by extractability.

The paper is written to be readable by practitioners, quants, and serious retail alike.

About the author

Matthew Butcher

Independent researcher, trader, and systems thinker. Matthew Butcher approaches markets the way he approaches worldbuilding: by looking for the hidden architecture beneath behavior. Arbitrage Funnel Theory emerged from live trading, microstructure observation, and a refusal to accept “markets just go up” as a sufficient explanation.

To discuss the paper, collaboration, or applications of AFT in practice, reach out: Email: [[email protected]]

Independent research Trading & microstructure Systems & incentives