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Title: A no-arbitrage perspective on global arbitrage opportunities

Author(s): Patrick Augustin, Mikhail Chernov, Lukas Schmid and Dongo Song

Publication Date: May 2020

Keyword(s): Anomalies, CIP violations, negative swap rates, no- arbitrage and Treasury basis

Programme Area(s): Financial Economics and International Macroeconomics and Finance

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.

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Bibliographic Reference

Augustin, P, Chernov, M, Schmid, L and Song, D. 2020. 'A no-arbitrage perspective on global arbitrage opportunities'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14774