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ABSTRACT. This study analyzes the pure arbitrage conditions across three of the “Anglo-Saxon capitalism” currencies: Australian dollar, British pound, and US dollar. We examine the relationship between spot-forward exchange rates and domestic-foreign interest rates in financial markets. We find that the most important determinants that contribute to the occurrence of pure arbitrage conditions are domestic spot currency rate and domestic interest rate. Daily data is collected from the DataStream/Thomson Reuters database and analyzed in probit regression models. The predicting accuracy check is conducted through in-sample and out-of-sample tests. Our results indicate that the level of significance for factor coefficients and prediction accuracy decrease with the time lag: the longer the time lag, the lower the prediction power. pp. 11–29
JEL codes: F31; G15

Keywords: foreign exchange; interest rate; currency risk; pure arbitrage; prediction power; probit model

How to cite: Bin, Leo, Jianguo Chen, and Peng Zhao (2016), “Conditions of Pure Arbitrage Applications: Evidence from Three Currencies,” Economics, Management, and Financial Markets 11(3): 11–29.

Received 7 January 2015 • Received in revised form 30 June 2015
Accepted 1 July 2015 • Available online 25 January 2016

LEO BIN
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Department of Business Administration,
University of Illinois at Springfield
(corresponding author)
JIANGUO CHEN
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School of Economics and Finance,
Massey University
PENG ZHAO
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School of Economics and Finance,
Massey University

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