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Financial innovation and arbitrage in the Spanish bond market

  • Alejandro Balbás

    ()

  • Susana López

    ()

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    This paper empirically tests the level of sequential arbitrage in the Spanish bond market. The test is implemented by drawing on default free and option free pure discount and coupon bonds issued by the Spanish government. This fact seems to be a clear distinction between this paper and the related empirical literature since there are no risky bonds or derivative securities involved in our analysis. As a consequence, the sequential arbitrage absence is just equivalent to the existence of a term structure of interest rates matching the whole set of bond prices as provided by The Bank of Spain. Thus, the main conclusions seem to be robust because they only depend on very general and simple hypotheses and, particularly, no dynamic assumptions are required. The results of the empirical analysis may be useful to traders and researchers since it seems to reveal the existence of sequential arbitrage. Furthermore, the number of arbitrage opportunities signi…cantly increased in 1998, when important innovations were implemented and, amongst other new possibilities, agents began trading each whole bond and its coupons (strips) separately. The inexperience associated with …nancial innovations may lead to ine¢ciencies in the market.

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    File URL: http://docubib.uc3m.es/WORKINGPAPERS/WB/wb010101.pdf
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    Paper provided by Universidad Carlos III, Departamento de Economía de la Empresa in its series Business Economics Working Papers with number wb010101.

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    Date of creation: Jan 2001
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    Handle: RePEc:cte:wbrepe:wb010101
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    1. Protopapadakis, Aris & Stoll, Hans R, 1983. " Spot and Futures Prices and the Law of One Price," Journal of Finance, American Finance Association, vol. 38(5), pages 1431-55, December.
    2. Kamara, Avraham & Miller, Thomas W., 1995. "Daily and Intradaily Tests of European Put-Call Parity," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 519-539, December.
    3. Kempf, Alexander & Korn, Olaf, 1998. "Trading System and Market Integration," Journal of Financial Intermediation, Elsevier, vol. 7(3), pages 220-239, July.
    4. Yacine Aït-Sahalia & Andrew W. Lo, 1998. "Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices," Journal of Finance, American Finance Association, vol. 53(2), pages 499-547, 04.
    5. Andrei Shleifer ad Robert W. Vishny, 1995. "The Limits of Arbitrage," Harvard Institute of Economic Research Working Papers 1725, Harvard - Institute of Economic Research.
    6. Mark Grinblatt & Francis A. Longstaff, 2000. "Financial Innovation and the Role of Derivative Securities: An Empirical Analysis of the Treasury STRIPS Program," Journal of Finance, American Finance Association, vol. 55(3), pages 1415-1436, 06.
    7. Jouini Elyes & Kallal Hedi, 1995. "Martingales and Arbitrage in Securities Markets with Transaction Costs," Journal of Economic Theory, Elsevier, vol. 66(1), pages 178-197, June.
    8. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers 0153, National Bureau of Economic Research, Inc.
    9. repec:fth:inseep:9513 is not listed on IDEAS
    10. deB. Harris, Frederick H. & McInish, Thomas H. & Shoesmith, Gary L. & Wood, Robert A., 1995. "Cointegration, Error Correction, and Price Discovery on Informationally Linked Security Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 563-579, December.
    11. Elton, Edwin J & Gruber, Martin J & Michaely, Roni, 1990. " The Structure of Spot Rates and Immunization," Journal of Finance, American Finance Association, vol. 45(2), pages 629-42, June.
    12. Kallal, Hedi & Jouini, Elyès, 1995. "Martingales and arbitrage in securities markets with transaction costs," Economics Papers from University Paris Dauphine 123456789/5630, Paris Dauphine University.
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