Execution Risk in High-Frequency Arbitrage
38 Pages Posted: 29 Mar 2012
There are 2 versions of this paper
Execution Risk in High-Frequency Arbitrage
How Riskless is 'Riskless' Arbitrage?
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: Suggested Citation
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