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One-Way Arbitrage-Based Interest Parity

Author

Listed:
  • Rosita P. Chang

    (University of Hawai'i)

  • Sang-Hyop Lee

    (University of Hawai'i)

  • Sean F. Reid

    (University of New Haven)

  • S. Ghon Rhee

    (University of Hawai'i)

Abstract

This study is motivated by two major considerations. First, the Fletcher andTaylor (1996) approach has yet to be applied to short-date markets to assess thediminishing role of transaction costs in explaining the devjatjons of observed forwardforeign exchange prices from interest parity forward prices. Second, the role oftransaction costs in one-way arbitrage-based interest parity has not been examined.Applying the Fletcher and Taylor approach to one-way arbitrage-based interest parity inshort-date capital markets, we document three major findings: (i) a narrower neutralband around interest parity line, as implied by one-way arbitrage, does not diminish therole of transaction costs; (ii) the varjances of the estimated deviations are a decreasingfunction of the time spent outside the transactions cost band; and (iii) the magnitude ofarbitrage profits tends to be small and economically insignificant though profitableopportunities are not rare in the short-date markets studied.

Suggested Citation

  • Rosita P. Chang & Sang-Hyop Lee & Sean F. Reid & S. Ghon Rhee, 2002. "One-Way Arbitrage-Based Interest Parity," Tinbergen Institute Discussion Papers 02-115/2, Tinbergen Institute.
  • Handle: RePEc:tin:wpaper:20020115
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    References listed on IDEAS

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