A No-Arbitrage Perspective on Global Arbitrage Opportunities

53 Pages Posted: 28 May 2020

See all articles by Patrick Augustin

Patrick Augustin

McGill University, Desautels Faculty of Management

Mikhail Chernov

UCLA Anderson

Lukas Schmid

University of Southern California - Marshall School of Business

Dongho Song

Johns Hopkins University - Carey Business School

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Date Written: May 2020

Abstract

We revisit the recent literature on persistent deviations from covered interest parity (CIP) by showing theoretically that CIP violations imply arbitrage opportunities only if uncollateralized interbank lending rates are riskless. In the absence of observable riskless discount rates, we extract them empirically using a simple no-arbitrage framework. They deliver novel quantitative benchmarks for foreign exchange contracts that match observed forward currency premiums and cross-currency basis swap rates well. The no-arbitrage benchmarks account for about two thirds of the alleged CIP deviations, while the residual pricing errors line up with measures of intermediary constraints and the expensiveness of the U.S. dollar.

JEL Classification: C1, E43, E44, G12, H60

Suggested Citation

Augustin, Patrick and Chernov, Mikhail and Schmid, Lukas and Song, Dongho, A No-Arbitrage Perspective on Global Arbitrage Opportunities (May 2020). CEPR Discussion Paper No. DP14774, Available at SSRN: https://ssrn.com/abstract=3612842

Patrick Augustin (Contact Author)

McGill University, Desautels Faculty of Management ( email )

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Quebec
Montreal, Quebec H3A 1G5
Canada

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Mikhail Chernov

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Lukas Schmid

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

Dongho Song

Johns Hopkins University - Carey Business School ( email )

Baltimore, MD 20036-1984
United States

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