I develop an equilibrium model of convergence trading and its impact on asset prices. Arbitrageurs

optimally decide how to allocate their limited capital over time. Their activity reduces

price discrepancies, but their activity also generates losses with positive probability, even if the

trading opportunity is fundamentally riskless. Moreover, prices of identical assets can diverge

even if the constraints faced by arbitrageurs are not binding. Occasionally, total losses are

large, making arbitrageurs' returns negatively skewed, consistent with the empirical evidence.

The model also predicts comovement of arbitrageurs' expected returns and market liquidity.