Bayesian arbitrage threshold analysis

A Bayesian estimation procedure is developed for estimating multiple-regime (multiple-threshold) error-correction models appropriate for deviations fr om financial arbitrage relationships. This approach has clear advantages ov er classical stepwise threshold autoregressive analysis. Unlike many other applications of threshold models, the knowledge of some costs involved in s etting up arbitrage positions allows us to specify an informative prior. To illustrate the Bayesian procedure, we estimate a no-arbitrage band within which index futures arbitrage is not profitable despite (persistent) deviat ions from parity.