Document Type

Journal Article

Department/Unit

Department of Finance and Decision Sciences

Title

Covered interest arbitrage profits: The role of liquidity and credit risk

Language

English

Abstract

We study the profitability of Covered Interest Parity (CIP) arbitrage violations and their relationship with market liquidity and credit risk using a novel and unique dataset of tick-by-tick firm quotes for all financial instruments involved in the arbitrage strategy. The empirical analysis shows that positive CIP arbitrage deviations include a compensation for liquidity and credit risk. Once these risk premia are taken into account, small arbitrage profits only accrue to traders who are able to negotiate low trading costs. The results are robust to stale pricing and the nonsynchronous trading occurring in the markets involved in the arbitrage strategy. © 2009 Elsevier B.V. All rights reserved.

Keywords

Arbitrage, Covered interest rate parity, Exchange rates, Foreign exchange microstructure

Publication Date

2010

Source Publication Title

Journal of Banking and Finance

Volume

34

Issue

5

Start Page

1098

End Page

1107

Publisher

Elsevier

DOI

10.1016/j.jbankfin.2009.11.008

ISSN (print)

03784266

ISSN (electronic)

18726372

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