Measuring Limits of Arbitrage in Fixed-Income Markets

Jean-Sebastien Fontaine and Guillaume Nolin

Staff Working Papers from Bank of Canada

Abstract: We use relative value to measure limits to arbitrage in fixed-income markets. Relative value captures apparent deviations from no-arbitrage relationships. It is simple, intuitive and can be computed model-free for any bond. A pseudo-trading strategy based on relative value generates higher returns than one based on the well-known noise measure. The relative value is therefore a better proxy for limits to arbitrage. We construct relative value indices for the US, UK, Japan, Germany, Italy, France, Switzerland and Canada. Limits to arbitrage increase with the scarcity of capital: we find that each index is correlated with local volatility and funding costs. Limits to arbitrage also exhibit strong commonality across countries, consistent with the international mobility of capital. The relative value indices are updated regularly and available publicly.

Keywords: Asset Pricing; Financial markets; International financial markets (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2017
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Citations: View citations in EconPapers (6)

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Related works:
Journal Article: MEASURING LIMITS OF ARBITRAGE IN FIXED‐INCOME MARKETS (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:17-44

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