Foreign Exchange Markets with Last Look

Mathematics and Financial Economics, Forthcoming

40 Pages Posted: 15 Jul 2015 Last revised: 1 May 2018

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Sebastian Jaimungal

University of Toronto - Department of Statistics

Jamie Walton

University College London - Department of Mathematics

Date Written: November 1, 2015

Abstract

We examine the Foreign Exchange (FX) spot price spreads with and without Last Look on the transaction. We assume that brokers are risk-neutral and they quote spreads so that losses to latency arbitrageurs (LAs) are recovered from other traders in the FX market. These losses are reduced if the broker can reject, ex-post, loss-making trades by enforcing the Last Look option which is a feature of some trading venues in FX markets. For a given rejection threshold the risk-neutral broker quotes a spread to the market so that her expected profits are zero. When there is only one venue, we find that the Last Look option reduces quoted spreads. If there are two venues we show that the market reaches an equilibrium where traders have no incentive to migrate. The equilibrium can be reached with both venues coexisting, or with only one venue surviving. Moreover, when one venue enforces Last Look and the other one does not, counterintuitively, it may be the case that the Last Look venue quotes larger spreads.

Keywords: Last Look, Foreign Exchange, Latency Arbitrage, Spamming, Spraying, Stale Quotes, Algorithmic Trading, Low Latency Traders, High-Frequency Trading

JEL Classification: G12, G13, G14, G28

Suggested Citation

Cartea, Álvaro and Jaimungal, Sebastian and Walton, Jamie, Foreign Exchange Markets with Last Look (November 1, 2015). Mathematics and Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2630662 or http://dx.doi.org/10.2139/ssrn.2630662

Álvaro Cartea

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Sebastian Jaimungal (Contact Author)

University of Toronto - Department of Statistics ( email )

100 St. George St.
Toronto, Ontario M5S 3G3
Canada

HOME PAGE: http://www.utstat.utoronto.ca/sjaimung

Jamie Walton

University College London - Department of Mathematics ( email )

Gower Street
London, WC1E 6BT
United Kingdom

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