TY - JOUR
T1 - The implied arbitrage mechanism in financial markets
AU - Chen, Shiyi
AU - Chng, Michael T.
AU - Liu, Qingfu
N1 - Publisher Copyright:
© 2020 Elsevier B.V.
PY - 2021/5
Y1 - 2021/5
N2 - The no-arbitrage condition is a cornerstone concept in financial market research. However, the arbitrage mechanism that is inherent in the trading process for related securities, is not readily observable. We develop a generalized smooth-transition vector error-correction model, or GST-VECM, to estimate the arbitrage mechanism from financial market data. The GST-VECM can (i) back out the implied no-arbitrage band, (ii) estimate arbitrage intensity for upper and lower bound violations, and (iii) accommodate convergence risk for statistical arbitrage. Using the introduction of CSI300 ETF trading in China as a natural experiment, we estimate the GST-VECM to reveal some insight into how a microstructural policy, by altering the index arbitrage mechanism, affects the pricing link between spot and futures markets.
AB - The no-arbitrage condition is a cornerstone concept in financial market research. However, the arbitrage mechanism that is inherent in the trading process for related securities, is not readily observable. We develop a generalized smooth-transition vector error-correction model, or GST-VECM, to estimate the arbitrage mechanism from financial market data. The GST-VECM can (i) back out the implied no-arbitrage band, (ii) estimate arbitrage intensity for upper and lower bound violations, and (iii) accommodate convergence risk for statistical arbitrage. Using the introduction of CSI300 ETF trading in China as a natural experiment, we estimate the GST-VECM to reveal some insight into how a microstructural policy, by altering the index arbitrage mechanism, affects the pricing link between spot and futures markets.
KW - Carry-cost adjusted basis
KW - Limits to arbitrage
KW - No-arbitrage band
UR - http://www.scopus.com/inward/record.url?scp=85089108351&partnerID=8YFLogxK
U2 - 10.1016/j.jeconom.2020.07.011
DO - 10.1016/j.jeconom.2020.07.011
M3 - Article
AN - SCOPUS:85089108351
SN - 0304-4076
VL - 222
SP - 468
EP - 483
JO - Journal of Econometrics
JF - Journal of Econometrics
IS - 1
ER -