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

Wai Ming Fong, Giorgio Valente*, Joseph K W FUNG

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    29 Citations (Scopus)

    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.

    Original languageEnglish
    Pages (from-to)1098-1107
    Number of pages10
    JournalJournal of Banking and Finance
    Volume34
    Issue number5
    DOIs
    Publication statusPublished - May 2010

    Scopus Subject Areas

    • Finance
    • Economics and Econometrics

    User-Defined Keywords

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

    Fingerprint

    Dive into the research topics of 'Covered interest arbitrage profits: The role of liquidity and credit risk'. Together they form a unique fingerprint.

    Cite this