Journal article

Bayesian arbitrage threshold analysis

CS Forbes, GRJ Kalb, P Kofman

Journal of Business and Economic Statistics | American Statistical Association | Published : 1999


A Bayesian estimation procedure is developed for estimating multiple-regime (multiple-threshold) error-correction models appropriate for deviations from financial arbitrage relationships. This approach has clear advantages over classical stepwise threshold autoregressive analysis. Unlike many other applications of threshold models, the knowledge of some costs involved in setting up arbitrage positions allows us to specify an informative prior. To illustrate the Bayesian procedure, we estimate a no-arbitrage band within which index futures arbitrage is not profitable despite (persistent) deviations from parity.