Toxic Arbitrage and Price Discovery

43 Pages Posted: 12 Apr 2017 Last revised: 21 Nov 2017

Kolja Johannsen

University of Warwick, Warwick Business School, Students

Date Written: November 20, 2017

Abstract

Toxic arbitrage opportunities are caused by information arriving in one market leading to short lived price deviations between markets. This paper shows that the direction of such arbitrage opportunities provides valuable insights into price discovery and markets’ information shares. Starting from a new theoretical framework of multi-venue trading, I derive an unbiased measure of information shares based on the frequency of toxic arbitrage opportunities. This measure has several advantages over traditional measures of price discovery, especially when looking at low liquidity environments, and provides a valuable addition in the analysis of price dynamics. I illustrate these advantages with a unique dataset for internationally traded foreign exchange futures.

Keywords: Price Discovery, Arbitrage, Adverse Selection, High Frequency Trading

JEL Classification: D53, F31, G10

Suggested Citation

Johannsen, Kolja, Toxic Arbitrage and Price Discovery (November 20, 2017). Available at SSRN: https://ssrn.com/abstract=2950161 or http://dx.doi.org/10.2139/ssrn.2950161

Kolja Johannsen (Contact Author)

University of Warwick, Warwick Business School, Students ( email )

West Midlands, CV4 7AL
United Kingdom

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