Scandinavian Working Papers in Economics

SIFR Research Report Series,
Institute for Financial Research

No 42: Arbitrage in the Foreign Exchange Market: Turning on the Microscope

Q. Farooq Akram , Dagfinn Rime () and Lucio Sarno
Additional contact information
Q. Farooq Akram: The Central Bank of Norway
Dagfinn Rime: The Central Bank of Norway
Lucio Sarno: University of Warwick and CEPR

Abstract: This paper investigates the presence and characteristics of arbitrage opportunities in the foreign exchange market using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, obtained from Reuters on special order. We provide evidence on the frequency, size and duration of round-trip and one-way arbitrage opportunities in real time. The analys is unveils the existence of numerous short-lived arbitrage opportunities, whose size is economically significant across exchange rates and comparable across different maturities of the instruments involved in arbitrage. The duration of arbitrage opportunities is, on average, high enough to allow agents to exploit deviations from the law of one price, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.

Keywords: Exchange rates; arbitrage; foreign exchange microstructure

JEL-codes: F31; F41; G14; G15

35 pages, February 15, 2006

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