Are there arbitrage opportunities in international finance?
Financial markets are commonly assumed to be efficient where potential lenders and borrowers almost continuously possess relevant information to rule out exploitable arbitrage opportunities. This assumption has been supported by numerous empirical studies that have been unable to detect short-term arbitrage opportunities in a variety of financial markets including the international foreign exchange and capital markets (Taylor, 1987). In periods of market volatility, however, some earlier studies have suggested that arbitrage opportunities may arise.1 However, the absence of arbitrage opportunities gives rise to the so-called ‘arbitrage paradox’, first pointed out by Grossman and Stiglitz (1976, 1980). That is, if arbitrage is never observed, market participants may not have sufficient incentives to watch the market, in which case arbitrage opportunities could arise. A possible resolution of this paradox is for very short-term arbitrage opportunities to arise, inviting traders to exploi
