Arbitrage in the Foreign Exchange Market: Turning on the Microscope
Qaisar Farooq Akram
BI Norwegian Business School
City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)
Norges Bank Working Paper No. 2005/12
EFA 2006 Zurich Meetings
This paper investigates the presence and characteristics of arbitrage opportunities in the foreign exchange market 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, obtained from Reuters on special order. We provide evidence on the frequency, size and duration of round-trip and one-way arbitrage opportunities in real time. The analysis unveils the existence of numerous short-lived arbitrage opportunities, whose size is economically significant across exchange rates and comparable across different maturities of the instruments involved in arbitrage. The duration of arbitrage opportunities is, on average, high enough to allow agents to exploit deviations from the law of one price, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.
Number of Pages in PDF File: 40
Keywords: exchange rates, arbitrage, covered interest rate parity, foreign exchange microstructure
JEL Classification: F31, F41, G14, G15
Date posted: March 6, 2006
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