Arbitrage in International Sovereign Debt Markets? Evidence from the Inflation Protected Securities of Six Countries
Journal of Money, Credit and Banking, Forthcoming
46 Pages Posted: 23 Dec 2019
Date Written: December 16, 2019
We consider an arbitrage strategy which exactly replicates the cash flow of a sovereign nominal bond using inflation swaps and inflation-linked bonds. The strategy reveals a violation of the law of one price in the G7 countries which is largest for the eurozone. Testing the strategy’s exposure to deflation, volatility, liquidity, and macroeconomic risks shows the observed mispricing is a risk premium which is more pronounced in the eurozone. We find less support that financial limits to arbitrage explain the mispricing. We conclude that pure long-run arbitrage opportunities persist when these strategies are exposed to intermediate financial risks.
Keywords: Inflation-Indexed Bonds, Nominal Bonds, Law of One Price, Mispricing, Limits to Arbitrage
JEL Classification: G12, G15, G18, H63
Suggested Citation: Suggested Citation