Financial innovation and arbitrage in the Spanish bond market

Susana López

DEE - Working Papers. Business Economics. WB from Universidad Carlos III de Madrid. Departamento de Economía de la Empresa

Abstract: 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 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 ine¢ciencies in the market.

Date: 2001-01
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