Arbitrage in international sovereign debt markets? Evidence from the inflation protected securities of six countries

We consider an arbitrage strategy that exactly replicates the cash flow of a sovereign nominal bond using inflation swaps and inflation-linked bonds. The strategy reveals a violation of the law of one price in the G7 countries, which is largest for the eurozone. Testing the strategy's exposure to deflation, volatility, liquidity, and macro-economic risks shows the observed mispricing is a risk premium, which is more pronounced in the eurozone. We find less support that financial limits to arbitrage explain the mispricing. We conclude that pure long-run arbitrage opportunities persist when these strategies are exposed to intermediate financial risks