Working Paper: CEPR ID: DP6878
Authors: Qaisar Farooq Akram; Dagfinn Rime; Lucio Sarno
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.
Keywords: arbitrage; covered interest rate parity; exchange rates; foreign exchange microstructure
JEL Codes: F31; F41; G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market inefficiencies (G14) | Arbitrage opportunities (G13) |
| Short-lived violations of CIP (P37) | Arbitrage opportunities (G13) |
| Market volatility (G17) | Frequency of arbitrage opportunities (G19) |
| Pace of markets (G19) | Size of arbitrage opportunities (G19) |
| Duration of arbitrage opportunities (C41) | Exploitation by agents (L85) |