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Execution Risk in High-Frequency Arbitrage

WBS Finance Group Research Paper No. 179

38 Pages Posted: 29 Mar 2012

See all articles by Roman Kozhan

Roman Kozhan

University of Warwick - Warwick Business School

Wing Wah Tham

University of New South Wales (UNSW)

Multiple version iconThere are 2 versions of this paper

Date Written: March 29, 2012

Abstract

In this paper, we investigate the role of execution risk in high-frequency trading through arbitrage strategies. We show that if rational agents face uncertainty about completing their arbitrage portfolios, then arbitrage is limited even in markets with perfect substitutes and convertibility. Using a simple model, we demonstrate that this risk arises from the crowding effect of competing arbitrageurs entering the same trade and inflicting negative externalities on each other. Our empirical results provide evidence that support the relevance of execution risk in high-frequency arbitrage.

Keywords: execution risk, limit to arbitrage, liquidity, high-frequency trading strategies

JEL Classification: D50, F31, G10

Suggested Citation

Kozhan, Roman and Tham, Wing Wah, Execution Risk in High-Frequency Arbitrage (March 29, 2012). WBS Finance Group Research Paper No. 179, Available at SSRN: https://ssrn.com/abstract=2030767 or http://dx.doi.org/10.2139/ssrn.2030767

Roman Kozhan (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Wing Wah Tham

University of New South Wales (UNSW)

Kensington
High St
Sydney, NSW 2052
Australia

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