Momentary exchange rate locked in a triangular mechanism of international currency

Myoung Shik Choi

Applied Economics, 2011, vol. 43, issue 16, 2079-2087

Abstract: This study uses two-way quoted data on major and nonmajor currencies to test the exchange rate dynamics. Particular attention is paid to the arbitrage and the spread in triangular foreign exchange trades. There is only one possible triangle when a bilateral exchange rate equals its trilateral rate. Otherwise, any third currency would potentially create arbitrage opportunities. Empirical testing evidence supports that small but possibly exploitable profitable arbitrage has significantly occurred over the very short haul of uncertainty and turbulence. In other words, we are convinced that the bilateral exchange rate could be diverged from one common currency side of the trilateral basket rates until markets function efficiently. This helps in better explaining foreign exchange rate movements. In addition, we find that the currency correlating decreases slightly but the volatility increases over time, as we expected.

Date: 2011
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DOI: 10.1080/00036840903035969

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