Testing Efficiency of an Arbitrage in Foreign Exchange Market (Forex): Simultaneous Ordering of Three Major Currency Pairs

In searching a market-neutral arbitrage strategy in forex market, we took a portfolio of three major currency pairs, EUR-USD, USD-JPY, and EUR-JPY. There are eight approaches, different cases of short and long positions; for example buying 1st and selling two others, etc. Historical daily FX rates were gathered since January 1990 until February 2011. Monthly covariances between daily growth rate of FX rates and monthly means of profit or loss of all approaches were calculated. Some different tests were applied. Eight approaches have been compared with each other in 28 states. Compared profit or loss of approaches in each state was calculated. With an ANOVA test, we found a that the difference between means of approaches was significant. We found that covariances often tend to be only positive or negative. We categorized different cases of covariances on the basis of its positive or negative signs in four categories. In each category, means of eight approaches were calculated and they have been compared binarilyin 28 states. There were relations between conditions of the categories (their negative or positive signs) and results of different approaches derived. It has been recommended to use a covariance indicator in forex softwares to make better orders. With computing the weighted average of approaches (on the basis of occurrence ratio of category) we found that BSS (buying 1st and selling the two others) and SSS (selling all the pairs) were the best approaches. They are not completely neutral, but in most of the time, they can eventuate to profit.