infonet-economy

Arbitrage ensures that covered interest parity holds. The condition
is central to price foreign exchange forwards and interbank lending
rates, and reflects the efficient functioning of markets. Normally,
deviations from arbitrage, if any, last seconds and reach a few basis
points. But after the Lehman bankruptcy, arbitrage broke down.
By replicating exactly two major arbitrage strategies and using high
frequency prices from novel datasets, this paper shows that arbitrage
profits were large, persisted for months and involved borrowing in dollars.
Empirical analysis suggests that insufficient funding liquidity in
dollars kept traders from arbitraging away excess profits.