Dec 12, 2008
FirstCaribbean revenue, profit diminished
FirstCaribbean Inter-national Bank Limited (FCIB) is expected to report year-end profits that have fallen off by US$80 million or 31 per cent when its earnings report becomes available.
[ more . . . ]

Dec 10, 2008
Global crisis hits Agostini’s rights issue
Agostini’s Ltd has suffered a shortfall in its rights issue which closed on October 22, 2008.
[ more . . . ]

Dec 08, 2008
BSE not fearful of crisis
THE Barbados Stock Exchange (BSE) does not foresee any major impact on its operations as a result of the global financial crisis
[ more . . . ]

Dec 08, 2008
FirstCaribbean affected by global financial crisis
THE current global financial condition has significantly impacted the net income of one the largest banks in the Caribbean.
[ more . . . ]

<< Opinions and Analysis

Taking a Chance on Arbitrage

April 1, 2004 - Published in the Business Section of the Trinidad Guardian

Much has been said about the gains on the Trinidad and Tobago Stock Exchange (TTSE). To date the composite index has generated a return of over 20% for the year. Yet little attention is paid to the fact that the equivalent index on the Jamaica Stock Exchange (JSE) has doubled that. That’s a return of over 40% in fewer than three months. There probably is a sound rationale for the unprecedented growth in Jamaica. Even though Standard and Poor downgraded the country rating for Jamaica in February 2004 the interest rate climate has softened causing funds to flow into the stock market.

More than just trying to figure out the cause of the Jamaican rally, participants in the T&T market should seek to understand the impact of the rally on the T&T market and vice versa. There is every reason to be interested since mixed up in these market movements is the relatively new phenomenon of cross listed companies. At present nine out of a total of thirty one companies on the TTSE are also listed on the JSE, the Barbados Stock Exchange (BSE) or both.

Companies that are listed on more than one exchange trade separately on each of those exchanges. The shares are exactly the same on each exchange and the company is exactly the same. Logically one would assume that they would trade at the same price. However if conditions isolated to a particular market result in a price movement that is not represented in the other cross listed market then an arbitrage opportunity arises.

Click on image to zoom in



Click on image to zoom in

Understanding Arbitrage

Before proceeding further it may be appropriate to define arbitrage. Arbitrage is one of the central tenets of financial economics enforcing the law of one price. It is defined as the “simultaneous purchase and sale of equivalent securities in two different markets in order to profit from discrepancies in their price relationship”. In accordance with the definition, arbitrage eventually causes the prices in both markets to be equal.

Over the past few weeks there has been much debate as to whether the local stock market is fairly valued or overvalued. From my perspective the purpose of the debate is not so much to determine an absolute value but to ensure that the market recognizes that there are concepts of value that must be used as reference points for evaluating a share price. Value can be intrinsic or it can be relative.

When dealing with cross listed companies, there are valuations relative to another market to consider.

Usually what should transpire in such an instance is that the share price is driven by the home market as this market would have more access to information on the company in question. Any misplaced pricing would then be acknowledged by the other markets and these satellite markets through arbitrage would quickly see a price adjustment to the value in the dominant market.

Having said this some of what we have witnessed during the past week flies in the face of all that should logically take place. As we would expect, the Jamaican resident companies are trading at a slight premium in Jamaica. What is surprising is that T&T resident companies are also trading at a premium in Jamaica and a significant premium at that.

Risk Free Profit

At one time during the course of last week, shares in RBTT were trading at $45.30 on the TTSE. At the same time these shares were trading at the TT equivalent of $61.75 on the JSE. An even bigger arbitrage opportunity was available on GHL which at one time was trading on the JSE at TT$50.96 gaining $1.25 on the day while on the TTSE the share was trading at $33.00 after falling 11 cents the previous day.

This means that to the extent that it is possible a person buying RBTT on the TTSE and simultaneously selling these shares on the JSE would have made a return of $16.45 equivalent to a 36% gain on the price listed on the TTSE. If the same were possible on the GHL shares the gain would have been $17.96 representing a return of 54% on the price listed on the TTSE.

In theory someone could profit from the above scenario without utilizing any capital and without risk. However in attempting this demand for shares on the TTSE would increase causing the price to rise and the supply on the JSE would also increase causing the share price to fall. An equilibrium point would be reached where both markets would reflect relatively the same price. The correction would be expected to take place faster on the JSE as they trade daily compared to the TTSE’s three days per week.

At the time of writing a week has gone by and the arbitrage opportunities still exist.

This suggests that both markets are not very integrated as they conspire to provide significant impediments that affect the arbitrage opportunity.

These impediments include transactions costs and taxes which are higher in Jamaica. In addition, even though the shares are cross listed one must for example have RBTT shares deposited in the Jamaica Central Depository in order to sell in Jamaica and the same applies to Trinidad. Further if you have bought shares in one market and would like to transfer them to the other market you would also incur a time lag and a fee to deposit the shares in the respective central depository.

Despite the above arbitrage gains are still possible, impediments simply reduce the size of the gain and increase the timeframe and therefore the risks involved in any arbitrage transaction. Logistically it is possible to manage these impediments. The larger issue is the availability of arbitrage information and the ability to accurately interpret that information.

Because this is all new to the market no real empirical evidence is available but it would be interesting to see how share prices would move when one market is being driven by falling interest rates and the other is being hindered by rising interest rates. The novelty to both T&T and Jamaican investors alike also means that arbitrage opportunities often go unexploited. That is why the price differential on GHL and RBTT described above was sustained for more than a week. Arbitrageurs should understand carefully the risks and recognize that such activity limits the degree of diversification in their portfolios. In addition the relative imperfections of the Caribbean markets, while giving rise to the arbitrage opportunity in the first place can also cause random movements in the arbitrage position between markets making it difficult to predict. This also makes it difficult to consistently realize those arbitrage profits.

Please send your comments to Ian Narine at iann@wisett.com

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