Arbitrage in the foreign exchange market: Turning on the microscope |
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Authors: | Q Farooq Akram Dagfinn Rime |
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Institution: | a Norges Bank, Research Department, Norges Bank, P.O. Box 1179 Sentrum, 0107 Oslo, Norway b Norges Bank and Norwegian University of Science and Technology, Research Department, Norges Bank, P.O. Box 1179 Sentrum, 0107 Oslo, Norway c University of Warwick, AXA Investment Managers and CEPR, Finance Group, Warwick Business School, University of Warwick, Coventry CV4 7AL, UK |
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Abstract: | This paper provides real-time evidence on the frequency, size, duration and economic significance of arbitrage opportunities in the foreign exchange market. We investigate deviations from the covered interest rate parity (CIP) condition using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency. The analysis unveils that: i) short-lived violations of CIP arise; ii) the size of CIP violations can be economically significant; iii) their duration is, on average, high enough to allow agents to exploit them, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency. |
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Keywords: | Exchange rates Arbitrage Covered interest rate parity Foreign exchange microstructure |
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