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Arbitrage in international sovereign debt markets? Evidence from the inflation protected securities of six countries

Arbitrage in international sovereign debt markets? Evidence from the inflation protected securities of six countries
Arbitrage in international sovereign debt markets? Evidence from the inflation protected securities of six countries
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.
inflation-indexed bonds, law of one price, limits to arbitrage, mispricing, nominal bonds
0022-2879
1417-1448
Kita, Arben
fd98ff4d-435a-4b69-8a7f-13171bf5c1fc
Tortorice, Daniel L.
72935ec6-7c72-492f-836f-10f38226804f
Kita, Arben
fd98ff4d-435a-4b69-8a7f-13171bf5c1fc
Tortorice, Daniel L.
72935ec6-7c72-492f-836f-10f38226804f

Kita, Arben and Tortorice, Daniel L. (2021) Arbitrage in international sovereign debt markets? Evidence from the inflation protected securities of six countries. Journal of Money, Credit & Banking, 53 (6), 1417-1448. (doi:10.1111/jmcb.12849).

Record type: Article

Abstract

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.

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Arbitrage in Sovreign Bonds JMCB - Accepted Manuscript
Restricted to Repository staff only until 28 April 2023.
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More information

Accepted/In Press date: 28 April 2021
e-pub ahead of print date: 30 June 2021
Published date: September 2021
Keywords: inflation-indexed bonds, law of one price, limits to arbitrage, mispricing, nominal bonds

Identifiers

Local EPrints ID: 448950
URI: http://eprints.soton.ac.uk/id/eprint/448950
ISSN: 0022-2879
PURE UUID: f88adc7c-da51-4c7c-af32-799948901b6f

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Date deposited: 11 May 2021 17:11
Last modified: 27 Apr 2022 07:00

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Contributors

Author: Arben Kita
Author: Daniel L. Tortorice

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