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

See all articles by Arben Kita

Arben Kita

University of Southampton

Daniel L. Tortorice

College of the Holy Cross -- Department of Economics and Accounting

Date Written: December 16, 2019

Abstract

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

Kita, Arben and Tortorice, Daniel L., Arbitrage in International Sovereign Debt Markets? Evidence from the Inflation Protected Securities of Six Countries (December 16, 2019). Journal of Money, Credit and Banking, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3505887 or http://dx.doi.org/10.2139/ssrn.3505887

Arben Kita (Contact Author)

University of Southampton ( email )

Highfield Campus
Building 2
Southampton, Hampshire SO17 1BJ
United Kingdom

Daniel L. Tortorice

College of the Holy Cross -- Department of Economics and Accounting ( email )

1 College Street
Worcester, MA 01610-2395
United States

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