A Circulation Network Model for the Exchange Rate Arbitrage Problem

33 Pages Posted: 20 Dec 2012 Last revised: 5 Feb 2014

See all articles by Carlos Cantú

Carlos Cantú

Bank for International Settlements (BIS) - Representative Office for the Americas

Edgar Possani

Instituto Tecnológico Autónomo de México (ITAM)

Date Written: December 20, 2012

Abstract

In this article we present a circulation network model for the detection of arbitrage opportunities in the currencies and securities markets. As an illustration we present its application to the interest rate of the Mexican and American bond market, the interbank loan rate of both countries, as well as to the deposits rate of US and Canada reported in Bloomberg. Deviations of covered interest rate parity imply that there exist a series of transactions that can be carried out to obtain riskless profits by exploiting arbitrage opportunities. The problem of finding arbitrage opportunities is modeled via a generalized maximum flow problem. The maximum flow over the generalized circulation network represents profits from arbitrage, and it’s obtained through the application of a minimum cost flow algorithm.

Keywords: arbitrage, currencies markets, circulation netwrok model

Suggested Citation

Cantú García, Carlos and Possani, Edgar, A Circulation Network Model for the Exchange Rate Arbitrage Problem (December 20, 2012). Available at SSRN: https://ssrn.com/abstract=2192185 or http://dx.doi.org/10.2139/ssrn.2192185

Carlos Cantú García

Bank for International Settlements (BIS) - Representative Office for the Americas ( email )

Switzerland

Edgar Possani (Contact Author)

Instituto Tecnológico Autónomo de México (ITAM) ( email )

Rio Hondo No. 1
Progreso Tizapan
Mexico City, D.F., 01080
Mexico
52 55 56284000 (Phone)

HOME PAGE: http://www.matematicas.itam.mx/

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