The implied arbitrage mechanism in financial markets

Shiyi Chen, Michael T. Chng*, Qingfu Liu

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

4 Citations (Scopus)


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.

Original languageEnglish
Pages (from-to)468-483
Number of pages16
JournalJournal of Econometrics
Issue number1
Publication statusPublished - May 2021


  • Carry-cost adjusted basis
  • Limits to arbitrage
  • No-arbitrage band


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