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One-Way Arbitrage-Based Interest Parity

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  • Rosita P. Chang

    (University of Hawai'i)

  • Sang-Hyop Lee

    (University of Hawai'i)

  • Sean F. Reid

    (University of New Haven)

  • S. Ghon Rhee

    ()
    (University of Hawai'i)

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    Abstract

    This study is motivated by two major considerations. First, the Fletcher andTaylor (1996) approach has yet to be applied to short-date markets to assess thediminishing role of transaction costs in explaining the devjatjons of observed forwardforeign exchange prices from interest parity forward prices. Second, the role oftransaction costs in one-way arbitrage-based interest parity has not been examined.Applying the Fletcher and Taylor approach to one-way arbitrage-based interest parity inshort-date capital markets, we document three major findings: (i) a narrower neutralband around interest parity line, as implied by one-way arbitrage, does not diminish therole of transaction costs; (ii) the varjances of the estimated deviations are a decreasingfunction of the time spent outside the transactions cost band; and (iii) the magnitude ofarbitrage profits tends to be small and economically insignificant though profitableopportunities are not rare in the short-date markets studied.

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    Bibliographic Info

    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 02-115/2.

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    Date of creation: 02 Dec 2002
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    Handle: RePEc:dgr:uvatin:20020115

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    1. McCormick, Frank, 1979. "Covered Interest Arbitrage: Unexploited Profits? Comment," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 411-17, April.
    2. Frenkel, Jacob A & Levich, Richard M, 1975. "Covered Interest Arbitrage: Unexploited Profits?," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 325-38, April.
    3. Hogan, Ked & Melvin, Michael & Roberts, Dan J., 1991. "Trade balance news and exchange rates: Is there a policy signal?," Journal of International Money and Finance, Elsevier, vol. 10(1, Supple), pages S90-S99, March.
    4. Frank McCormick, 1979. "Covered-interest arbitrage: unexploited profits: comment," International Finance Discussion Papers 132, Board of Governors of the Federal Reserve System (U.S.).
    5. Popper, Helen, 1993. "Long-term covered interest parity: evidence from currency swaps," Journal of International Money and Finance, Elsevier, vol. 12(4), pages 439-448, August.
    6. Chang, Yuanchen & Taylor, Stephen J., 1998. "Intraday effects of foreign exchange intervention by the Bank of Japan1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 191-210, February.
    7. Fletcher, Donna J & Taylor, Larry W, 1996. ""Swap" Covered Interest Parity in Long-Date Capital Markets," The Review of Economics and Statistics, MIT Press, vol. 78(3), pages 530-38, August.
    8. Clinton, Kevin, 1988. "Transactions Costs and Covered Interest Arbitrage: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 358-70, April.
    9. Frenkel, Jacob A & Levich, Richard M, 1977. "Transaction Costs and Interest Arbitrage: Tranquil versus Turbulent Periods," Journal of Political Economy, University of Chicago Press, vol. 85(6), pages 1209-26, December.
    10. Maasoumi, Esfandiar & Pippenger, John, 1989. "Transaction Costs and the Interest Parity Theorem: Comment," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 236-43, February.
    11. Fletcher, Donna J. & Taylor, Larry W., 1994. "A non-parametric analysis of covered interest parity in long-date capital markets," Journal of International Money and Finance, Elsevier, vol. 13(4), pages 459-475, August.
    12. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
    13. Rhee, S Ghon & Chang, Rosita P, 1992. " Intra-day Arbitrage Opportunities in Foreign Exchange and Eurocurrency Markets," Journal of Finance, American Finance Association, vol. 47(1), pages 363-79, March.
    14. Husted, Steven & Kitchen, John, 1985. "Some Evidence on the International Transmission of U.S. Money Supply Announcement Effects," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(4), pages 456-66, November.
    15. Deardorff, Alan V, 1979. "One-Way Arbitrage and Its Implications for the Foreign Exchange Markets," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 351-64, April.
    16. Woodward, R S, 1988. "Some New Evidence on the Profitability of One-Way versus Round-Trip Arbitrage," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(4), pages 645-52, November.
    17. Bahmani-Oskooee, Mohsen & Das, Satya P, 1985. "Transaction Costs and the Interest Parity Theorem," Journal of Political Economy, University of Chicago Press, vol. 93(4), pages 793-99, August.
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