MEASURING LIMITS OF ARBITRAGE IN FIXED‐INCOME MARKETS

Jean-Sebastien Fontaine and Guillaume Nolin

Journal of Financial Research, 2019, vol. 42, issue 3, 525-552

Abstract: An emerging literature relies on an index of limits of arbitrage in fixed‐income markets. We analyze the benefits of an index that is model‐free, robust, and intuitive. This new index strengthens the evidence that limits of arbitrage proxy for risks priced in the cross‐section of returns. Trading simulations show that the new index improves identification of limits of arbitrage because it bypasses a noisy estimation step. Relative value indices in the United States, United Kingdom, Japan, Germany, Italy, France, Switzerland, and Canada exhibit strong commonality and high correlations with local volatility and funding conditions. The indices are updated regularly and available publicly.

Date: 2019
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https://doi.org/10.1111/jfir.12187

Related works:
Working Paper: Measuring Limits of Arbitrage in Fixed-Income Markets (2017)
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