Interest Rate Parity and the Behavior of the Bid-Ask Spread

Posted: 7 Nov 2006 Last revised: 10 May 2010

See all articles by Henock Louis

Henock Louis

Pennsylvania State University - Smeal College of Business

Lloyd P. Blenman

University of North Carolina (UNC) at Charlotte - Department of Finance & Business Law

Janet S. Thatcher

University of Wisconsin - Whitewater

Date Written: May 10, 2010

Abstract

A stochastic frontier regression model is used to test interest rate parity with bid-ask spreads for the Belgian franc, the Deutschmark, and the Swiss franc. The forward markets tested have become efficient in the sense that IRP holds well. The bounds provided by IRP do not appear to be binding, however. Evidence is provided that in spite of the overall goodness of fit of the model, the arbitrage margins are sometimes violated, implying possible arbitrage opportunities. The percentage-bid-ask spread is consistently higher for the Belgian franc than for the Deutschmark and the Swiss franc. Spreads are increasing functions of the time to maturity and volatility. Spread-size clustering is more severe than price-level clustering and appears to be inversely related to volatility and positively related to the trading volume. No evidence is found of significant calendar-day effects on spread size.

Keywords: Interest rate parity, bid-ask spread, Foreign exchange

JEL Classification: E43, F31

Suggested Citation

Louis, Henock and Blenman, Lloyd P. and Thatcher, Janet S., Interest Rate Parity and the Behavior of the Bid-Ask Spread (May 10, 2010). Journal of Financial Research, Vol. 22, No. 2, p. 189, Summer 1999. Available at SSRN: https://ssrn.com/abstract=942683

Henock Louis (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802-3306
United States
814-865-4160 (Phone)
814-863-8393 (Fax)

Lloyd P. Blenman

University of North Carolina (UNC) at Charlotte - Department of Finance & Business Law ( email )

9201 University City Blvd.
Charlotte, NC 28223
United States
704-687-7705 (Phone)

Janet S. Thatcher

University of Wisconsin - Whitewater ( email )

800 W. Main
College of Business and Economics Department of Finance
Whitewater, WI 53190
United States
(262) 472-5462 (Phone)
(262) 472-4863 (Fax)

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