Limits to Arbitrage During the Crisis: Funding Liquidity Constraints and Covered Indterst Parity
Type
presentation
Date Issued
2012-11-08
Author(s)
Abstract
Arbitrage ensures that covered interest parity holds. The condition
is central to price foreign exchange forwards and interbank lending
rates, and reflects the efficient functioning of markets. Normally,
deviations from arbitrage, if any, last seconds and reach a few basis
points. But after the Lehman bankruptcy, arbitrage broke down.
By replicating exactly two major arbitrage strategies and using high
frequency prices from novel datasets, this paper shows that arbitrage
profits were large, persisted for months and involved borrowing in dollars.
Empirical analysis suggests that insufficient funding liquidity in
dollars kept traders from arbitraging away excess profits.
is central to price foreign exchange forwards and interbank lending
rates, and reflects the efficient functioning of markets. Normally,
deviations from arbitrage, if any, last seconds and reach a few basis
points. But after the Lehman bankruptcy, arbitrage broke down.
By replicating exactly two major arbitrage strategies and using high
frequency prices from novel datasets, this paper shows that arbitrage
profits were large, persisted for months and involved borrowing in dollars.
Empirical analysis suggests that insufficient funding liquidity in
dollars kept traders from arbitraging away excess profits.
Language
English
Keywords
limits to arbitrage
covered interest parity
funding liquidity
finanan-
cial crisis
cial crisis
slow moving capital
market freeze
unconventional monetary policy.
HSG Classification
contribution to scientific community
Refereed
No
Event Title
Swissquote Conference 2012 on Liquidity and Systemic Risk
Event Location
EPFL Lausanne
Subject(s)
Division(s)
Eprints ID
220307
File(s)![Thumbnail Image]()
Name
12_12_Ranaldo et al_Limits to Arbitrage.pdf
Size
1.01 MB
Format
Adobe PDF
Checksum (MD5)
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