Forex swap premiums, shock response and covered profits: an ARDL–EGARCH model analysis

ABSTRACT

This article develops an autoregressive distributed lag-exponential GARCH (ARDL–EGARCH) model to explore the formation mechanism of covered profits from the perspectives of forex swap premiums and shock response, considering eight arbitrage strategies on four currency pairs as a case study. Two important conclusions emerge: first, the stronger the currency, the more the opportunity for lucrative unidirectional arbitrage; second, covered profits result from profit memory, the dynamic adjustment of market expectation from forex swap premiums and the asymmetric volatility clustering of shock response.

KEYWORDS:

• Covered arbitrage
• covered profits
• forex swap premiums
• shock response
• ARDL–EGARCH

JEL CLASSIFICATION:

• C32
• F31
• G15

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by the Zhejiang Provincial Natural Science Foundation of China [LY18G010006] and Scientific Research Foundation of Zhejiang A&F University [2017FR018].