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Profit Possibilities in Currency Markets: Arbitrage, Hedging, and Speculation

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  • Dilip K. Ghosh
  • Augustine C. Arize

Abstract

This paper reviews and extends the existing literature on covered arbitrage, delineates the conditions for profitable arbitrage with the hedging instruments of forward and options contracts in the foreign exchange markets, and defines the maximum possible profits out of a given market environment. Next, the simple rules on speculation are articulated with and without transaction costs, and then we show how speculation can be covered with options and forwards. Finally, speculation is integrated with arbitrage and hedging, and further compounding of profit possibilities is illustrated.

Suggested Citation

  • Dilip K. Ghosh & Augustine C. Arize, 2003. "Profit Possibilities in Currency Markets: Arbitrage, Hedging, and Speculation," The Financial Review, Eastern Finance Association, vol. 38(3), pages 473-496, August.
    • Handle: RePEc:bla:finrev:v:38:y:2003:i:3:p:473-496
    DOI: 10.1111/1540-6288.00056
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    References listed on IDEAS

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    5. Dilip K. Ghosh & Arun J. Prakash, 2001. "Strategic Rules On Speculation In The Foreign Exchange Market," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(1), pages 15-26, March.
    6. Dalal, Ardeshir J., 1979. "Decision rules for an investor in forward exchange markets," Journal of International Economics, Elsevier, vol. 9(4), pages 539-558, November.
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    8. Tsiang, S C, 1973. "Spot Speculation, Forward Speculation, and Arbitrage: A Clarification and Reply," American Economic Review, American Economic Association, vol. 63(5), pages 999-1002, December.
    9. S.C. Tsiang, 1973. "Spot Speculation, Forward Speculation and Arbitrage: A Clarification and Reply," UP School of Economics Discussion Papers 197310, University of the Philippines School of Economics.
    10. Ghosh, Dilip K, 1997. "Profit Multiplier in Covered Currency Trading with Leverage," The Financial Review, Eastern Finance Association, vol. 32(2), pages 391-409, May.
    11. D. K. Ghosh, 1997. "Arbitrage with hedging by forward contracts: exploited and exploitable profits," The European Journal of Finance, Taylor & Francis Journals, vol. 3(4), pages 349-361.
    12. Deardorff, Alan V, 1979. "One-Way Arbitrage and Its Implications for the Foreign Exchange Markets," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 351-364, April.
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    Cited by:

    1. Arize, Augustine C. & Malindretos, John & Ghosh, Dilip, 2015. "Purchasing power parity-symmetry and proportionality: Evidence from 116 countries," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 69-85.
    2. Hailong Jin & E. Kwan Choi, 2013. "China's Profits and Losses from Currency Intervention, 1994-2011," CESifo Working Paper Series 4551, CESifo.
    3. Jin, Hailong, 2013. "Essays on currency intervention, with particular reference to Chinese economy," ISU General Staff Papers 201301010800004079, Iowa State University, Department of Economics.
    4. Arize, A. C. & Malindretos, John & Grivoyannis, Elias C., 2005. "Inflation-rate volatility and money demand: Evidence from less developed countries," International Review of Economics & Finance, Elsevier, vol. 14(1), pages 57-80.
    5. Ghosh, Dilip K. & Ghosh, Dipasri & Bhatnagar, Chandra Shekhar, 2010. "Cross-listed cross-currency assets and arbitrage with forwards and options," Global Finance Journal, Elsevier, vol. 21(1), pages 98-110.
    6. Jin, Hailong & Choi, E. Kwan, 2013. "Profits and losses from currency intervention," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 14-20.
    7. Choi, E. Kwan & Jin, Hailong, 2014. "Currency intervention and consumer welfare in an open economy," International Review of Economics & Finance, Elsevier, vol. 29(C), pages 47-56.
    8. Berhanu, Denu, 2006. "Dynamic Money Demand Function for Ethiopia," Ethiopian Journal of Economics, Ethiopian Economics Association, vol. 12(2), pages 1-81, November.
    9. Ghosh, Dilip K. & Arize, Augustine & Ghosh, Dipasri, 2015. "Trades in commodities, financial assets, and currencies: A triangle of arbitrage, hedging and speculative designs," Global Finance Journal, Elsevier, vol. 28(C), pages 1-9.

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