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Arbitrage Risk and Market Efficiency: The Case of Treasury Bill Futures

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  • Lin, James Wuh

Abstract

This article explores arbitrage risk and models a testable hypothesis for studies in the treasury bill futures market efficiency. The modern mean-variance theory applied to a hedged arbitrage portfolio is used for the analysis. For a given expected arbitrage profit, we derive minimum variance arbitrage (MVA) conditions. A minimum variance arbitrage line (MVAL) is then derived to show the risk-return tradeoff for arbitrage. Market efficiency conditions are discussed by taking into account arbitrate risk along with bid-ask spreads. The analysis in this study helps explain the puzzle of inefficiencies in the T-bill futures market. Because refinancing and variation margin (due to marking-to-market) are required for arbitrage using futures trading in general, our ex ante arbitrage model using the case of T-bill futures can be applied to other futures markets. Copyright 1996 by Kluwer Academic Publishers

Suggested Citation

  • Lin, James Wuh, 1996. "Arbitrage Risk and Market Efficiency: The Case of Treasury Bill Futures," Review of Quantitative Finance and Accounting, Springer, vol. 7(2), pages 187-203, September.
    • Handle: RePEc:kap:rqfnac:v:7:y:1996:i:2:p:187-203
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