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A No-Arbitrage Perspective on Global Arbitrage Opportunities

Patrick Augustin, Mikhail Chernov, Lukas Schmid, Dongho Song

NBER Working Paper No. 27231
Issued in May 2020, Revised in July 2020
NBER Program(s):Asset Pricing, International Finance and Macroeconomics

We revisit the recent literature on persistent deviations from covered interest parity (CIP) by showing theoretically that CIP violations imply arbitrage opportunities only if uncollateralized interbank lending rates are riskless. In the absence of observable riskless discount rates, we extract them empirically using a simple no-arbitrage framework. They deliver novel quantitative benchmarks for foreign exchange contracts that match observed forward currency premiums and cross-currency basis swap rates well. The no-arbitrage benchmarks account for about two thirds of the alleged CIP deviations, while the residual pricing errors line up with measures of intermediary constraints and the expensiveness of the U.S. dollar.

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Document Object Identifier (DOI): 10.3386/w27231

 
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