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Measuring the degree of fulfillment of the law of one price. Applications to financial markets integration

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  • Balbás, Alejandro
  • Muñoz-Bouzo, María José

Abstract

This paper gives two measures of the degree of fulfillment of the Law of One Price. These measures are characterized by means of saddle point conditions, and are therefore easy to compute in practical situations. Many empirical papers analyze well-Known arbitrage strategies. Our measures present an important advantage over this approach, since we globally focus on the market to find its arbitrage opportunities, without studying special strategies. The developed theory is also applied to markets with frictions, and to study the integration of different financial markets. Our measures are continuous with respect to previous measures in the literature, and seem to be better than them since they compute how much money the agents can win due to the arbitrage opportunities in a financial market, or among different ones.

Suggested Citation

  • Balbás, Alejandro & Muñoz-Bouzo, María José, 1996. "Measuring the degree of fulfillment of the law of one price. Applications to financial markets integration," UC3M Working papers. Economics 7213, Universidad Carlos III de Madrid. Departamento de Economía.
    • Handle: RePEc:cte:werepe:7213
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    References listed on IDEAS

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    1. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
    2. Chamberlain, Gary & Rothschild, Michael, 1983. "Arbitrage, Factor Structure, and Mean-Variance Analysis on Large Asset Markets," Econometrica, Econometric Society, vol. 51(5), pages 1281-1304, September.
    3. 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(4), pages 563-579, December.
    4. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 287-325.
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    Keywords

    Law of one price;

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