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Financial innovation and arbitrage in the Spanish bond market
Susana López |
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This paper empirically tests the level of sequential arbitrage in the Spanish bond
market. The test is implemented by drawing on default free and option free pure discount and
coupon bonds issued by the Spanish government. This fact seems to be a clear distinction
between this paper and the related empirical literature since there are no risky bonds or
derivative securities involved in our analysis. As a consequence, the sequential arbitrage absence
is just equivalent to the existence of a term structure of interest rates matching the whole set of
bond prices as provided by The Bank of Spain. Thus, the main conclusions seem to be robust
because they only depend on very general and simple hypotheses and, particularly, no dynamic
assumptions are required. The results of the empirical analysis may be useful to managers,
traders and researchers since it seems to reveal the existence of sequential arbitrage.
Furthermore, the number of arbitrage opportunities significantly increased in 1998, when
important innovations were implemented and, amongst other new possibilities, agents began
trading each whole bond and its coupons (strips) separately. The inexperience associated with
financial innovations may lead to inefficiencies in the market.
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