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Arbitrage in the foreign exchange market: Turning on the microscope

  • Q. Farooq Akram,

    (Norges Bank (Central Bank of Norway))

  • Dagfinn Rime

    (Norges Bank (Central Bank of Norway))

  • Lucio Sarno

    (University of Warwick and CEPR)

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 fre- quency, size and duration of round-trip and one-way arbitrage opportunities in real time. The analysis unveils the existence of numerous short-lived arbitrage oppor- tunities, 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 devia- tions 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.

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Paper provided by Norges Bank in its series Working Paper with number 2005/12.

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Length: 43 pages
Date of creation: 09 Nov 2005
Date of revision:
Handle: RePEc:bno:worpap:2005_12
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