Arbitrage in the Foreign Exchange Market: Turning on the Microscope

Norges Bank Working Paper No. 2005/12

EFA 2006 Zurich Meetings

40 Pages Posted: 6 Mar 2006  

Qaisar Farooq Akram

Norges Bank

Dagfinn Rime

BI Norwegian Business School

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2006

Abstract

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.

Keywords: exchange rates, arbitrage, covered interest rate parity, foreign exchange microstructure

JEL Classification: F31, F41, G14, G15

Suggested Citation

Akram, Qaisar Farooq and Rime, Dagfinn and Sarno, Lucio, Arbitrage in the Foreign Exchange Market: Turning on the Microscope (February 2006). Norges Bank Working Paper No. 2005/12; EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=887442 or http://dx.doi.org/10.2139/ssrn.887442

Qaisar Farooq Akram

Norges Bank ( email )

Bankplassen 2
P.O. Box 1179
Oslo, N-0107
Norway

Dagfinn Rime (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway
+47-46410507 (Phone)

HOME PAGE: http://home.bi.no/dagfinn.rime/

Lucio Sarno

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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