Arbitrage in the foreign exchange market: Turning on the microscope
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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CIP(Covered Interest rate Parity) in the FX Market
where 
No-arbitrage condition
where a : ask rate, b : bid rate
Data and Calculations of Returns from Arbitrage
formulas used for the calculations
- where the first term on the right-hand side of each equation represents market swap
points for a given maturity obtained from Reuters, while the second term represents the
corresponding derived swap points
- it is profitable if above formulas are positive.
data
February 13 to September 30 2004 from Reuters. major three exchange rates at four different maturities : 1, 3, 6, 12 months.
Frequency, Size, Duration and Economic Significance of Arbitrage Opportunities
Frequency and Size
Duration
Robustness and Further Analysis
Are Arbitrage Opportunities Genuine or Due to Stale Quotes
Is Any of the Assets Involved in Arbitrage Priced Using No-arbitrage Conditions
Day of the Week and Hours of the Day Effects
The Role of Market Pace and Volatility
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