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Arbitrage in International Sovereign Debt Markets? Evidence from the Inflation‐Protected Securities of Six Countries
Author(s) -
KITA ARBEN,
TORTORICE DANIEL L.
Publication year - 2021
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12849
Subject(s) - arbitrage , economics , bond , monetary economics , volatility (finance) , deflation , inflation (cosmology) , debt , market liquidity , fixed income arbitrage , risk arbitrage , financial economics , monetary policy , arbitrage pricing theory , capital asset pricing model , finance , physics , theoretical physics
We consider an arbitrage strategy that exactly replicates the cash flow of a sovereign nominal bond using inflation swaps and inflation‐linked bonds. The strategy reveals a violation of the law of one price in the G7 countries, which is largest for the eurozone. Testing the strategy's exposure to deflation, volatility, liquidity, and macro‐economic risks shows the observed mispricing is a risk premium, which is more pronounced in the eurozone. We find less support that financial limits to arbitrage explain the mispricing. We conclude that pure long‐run arbitrage opportunities persist when these strategies are exposed to intermediate financial risks.