Arbitrage Risk and Market Efficiency: The Case of Treasury Bill Futures

James Wuh Lin

Review of Quantitative Finance and Accounting, 1996, vol. 7, issue 2, 187-203

Abstract: This article explores arbitrage risk and models a testable hypothesis for studies in the treasury bill futures market efficiency. The modern mean-variance theory applied to a hedged arbitrage portfolio is used for the analysis. For a given expected arbitrage profit, we derive minimum variance arbitrage (MVA) conditions. A minimum variance arbitrage line (MVAL) is then derived to show the risk-return tradeoff for arbitrage. Market efficiency conditions are discussed by taking into account arbitrate risk along with bid-ask spreads. The analysis in this study helps explain the puzzle of inefficiencies in the T-bill futures market. Because refinancing and variation margin (due to marking-to-market) are required for arbitrage using futures trading in general, our ex ante arbitrage model using the case of T-bill futures can be applied to other futures markets. Copyright 1996 by Kluwer Academic Publishers

Date: 1996
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