Covered interest arbitrage with transaction costs: An evidence from the Hong Kong foreign exchange market

This paper deals with the effects of transaction costs on the efficacy of covered and one-way interest arbitrage under the linked exchange rate system in the Hong Kong foreign exchange market. First, we examine the arbitrage opportunities in the swap market and in domestic and foreign securities markets. Second, we measure the profitability of covered interest arbitrage and one-way arbitrage. Empirical findings have shown that allowing for transaction costs, covered interest arbitrage seems to entail less unexploited opportunities for profit. However, there exists a great deal of unexploited profit opportunities in one-way arbitrage in the Hong Kong financial market.We are grateful to two anonymous referees and the editor for their helpful comments on an earlier version of this paper.