Law of one price (LOOP) explained: Arbitraging strategy on cross-listings (Excel)

[@NEDLeducation]

You can find the spreadsheets for this video and some additional materials here: drive.google.com/drive/folders/1sP40IW0p0w5IETCgo464uhDFfdyR6rh7 Please consider supporting NEDL on Patreon: www.patreon.com/NEDLeducation

[@maxweber2253]

Awesome

[@ericxiao6052]

With respect to the unit root test and the following interpretation that the LOOP breaks down in the "after" effects. How can this be the case if we are seeing the arb disappear precisely during that period - with the LOOP stating that assets with equivalent cash flows should be priced the same. Shouldn't the LOOP be broken prior (in the period where we are seeing arb profits?). Thanks

[@NEDLeducation]

Hi Eric, and thanks for the excellent question! Obviously if you would like to consider a very stringent form of LOOP where prices should immediately adjust to parity and not deviate at all, you should not expect to see any abnormal returns whatsoever. However, if we treat LOOP as a more long-run interpretation (prices should converge to parity quite quickly but perhaps not immediately), unit root test is helpful. Here we see that the adjustments took place before 2020 and were not that notable afterwards, which is also verifiable graphically. Hope it helps!

[@ericxiao6052]

@@NEDLeducationmakes sense. Thanks!

[@cousinsdailylife4813]

Hi I just wanna know what are the disadvantages of loop

[@NEDLeducation]

Hi, and thanks for the question! I guess you can call a disadvantage the fact that it does not always work well, as shown in the video :) Additionally, to trade based on LOOP, you have got a quite limited number of pairs, and they are most likely trading in different jurisdictions, so fees and other costs might be high. Hope it helps!

[@cousinsdailylife4813]

@@NEDLeducation thank you