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Australian Money Market Divergence: Arbitrage Opportunity or Illusion?


  • Belinda Cheung

    (Reserve Bank of Australia)

  • Sebastien Printant

    (Reserve Bank of Australia)


In recent years, the spread between money market interest rates has widened. One implication is that the price of Australian dollars diverges across these markets. Even after risks associated with creditworthiness, liquidity and other factors have been taken into account, it appears that unexploited arbitrage opportunities persist. Typically the literature only assesses the profitability of arbitrage by calculating the return from funding at low money market rates to invest at higher rates. However, banks have broader balance sheet considerations that need to be taken into account. We therefore take a 'whole-of-balance-sheet' approach to assessing the potential for arbitrage opportunities available to the four major banks in Australia. this takes into consideration that banks optimise their balance sheet not only by funding themselves at the lowest possible rates to maximise profitability, but also for compliance with prudential regulation, maintenance of capital adequacy, and opportunity cost in asset allocation. We find that once asset-specific funding costs are taken into account, short-term money market trades would have generally not been profitable for the major banks. Overall, the incentive for banks to arbitrage has fallen since 2008. Our result reflects both a rise in the cost of debt funding relative to market returns and an increase in the share of equity funding. We also note that the deployment of balance sheet space to money market trading incurs a significant opportunity cost, when compared to lending for residential housing. Not surprisingly, the balance sheets of the major banks are therefore skewed toward more profitable lending activities, rather than money market trading.

Suggested Citation

  • Belinda Cheung & Sebastien Printant, 2019. "Australian Money Market Divergence: Arbitrage Opportunity or Illusion?," RBA Research Discussion Papers rdp2019-09, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp2019-09

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    References listed on IDEAS

    1. Vladyslav Sushko & Claudio Borio & Robert Neil McCauley & Patrick McGuire, 2016. "The failure of covered interest parity: FX hedging demand and costly balance sheets," BIS Working Papers 590, Bank for International Settlements.
    2. Dagfinn Rime & Andreas Schrimpf & Olav Syrstad, 2017. "Segmented money markets and covered interest parity arbitrage," BIS Working Papers 651, Bank for International Settlements.
    3. Nina Boyarchenko & Thomas M. Eisenbach & Pooja Gupta & Or Shachar & Peter Van Tassel, 2018. "Bank-Intermediated Arbitrage," Liberty Street Economics 20181018, Federal Reserve Bank of New York.
    4. Claudio Borio & Robert Neil McCauley & Patrick McGuire & Vladyslav Sushko, 2016. "Covered interest parity lost: understanding the cross-currency basis," BIS Quarterly Review, Bank for International Settlements, September.
    5. Sofiane Aboura & Emmanuel Lépinette, 2015. "Do banks satisfy the Modigliani-Miller theorem?," Economics Bulletin, AccessEcon, vol. 35(2), pages 924-935.
    6. William R. Cline, 2015. "Testing the Modigliani-Miller Theorem of Capital Structure Irrelevance for Banks," Working Paper Series WP15-8, Peterson Institute for International Economics.
    7. Bajaj , Rasna & Binmore, Andrew & Dasgupta, Rupak & Vo, Quynh-Anh, 2018. "Banks’ internal capital markets: how do banks allocate capital internally?," Bank of England Quarterly Bulletin, Bank of England, vol. 58(2), pages 1-10.
    8. repec:dau:papers:123456789/13839 is not listed on IDEAS
    9. Tim Atkin & Belinda Cheung, 2017. "How Have Australian Banks Responded to Tighter Capital and Liquidity Requirements?," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 41-50, June.
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    More about this item


    arbitrage; banks; funding costs; money markets;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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