Deviations from Triangular Arbitrage Parity in Foreign Exchange and Bitcoin Markets

Abstract

This paper applies recently developed procedures to monitor and date
so-called “financial market dislocations”, defined as periods in which
substantial deviations from arbitrage parities take place. In particular, we
use a cointegration perspective to focus on deviations from the triangular
arbitrage parity for exchange rate triplets. Due to increasing attention on
and importance of mispricing in the market for cryptocurrencies, we include
the cryptocurrency Bitcoin in addition to fiat currencies in our analysis. We
do not find evidence for substantial deviations from the triangular arbitrage
parity when only traditional fiat currencies are considered, but document
significant deviations from triangular arbitrage parities in the newer market
for Bitcoin. We tentatively confirm the importance of our results for portfolio
strategies by showing that a currency portfolio that trades based on our
detected break-points outperforms a simple buy-and-hold strategy.