Spot Arbitrage in FX Market and Algorithmic Trading: Speed Is Not of the Essence

37 Pages Posted: 20 Sep 2017

See all articles by Soheil Mahmoodzadeh

Soheil Mahmoodzadeh

University of Cambridge - Faculty of Economics

Michael Tseng

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Ramazan Gencay

Simon Fraser University

Date Written: March 24, 2017

Abstract

This paper studies the properties of spot arbitrage opportunities in the interdealer foreign exchange market. We cast into question current understanding of spot FX arbitrage in the literature, specifically vis-á-vis algorithmic trading. The presence of algorithmic traders does not offer significant improvement in price discovery by quickly detecting and exploiting mispricing of currency pairs.Traders - algorithmic or otherwise - in fact mostly do not exploit spot arbitrage opportunities in the market. To the contrary, algorithmic trading facilitates the creation of arbitrage by tighter liquidity provision. This effect is blunted by microstructure frictions, resulting in decreasing number of arbitrage opportunities.

Keywords: Foreign Exchange Market, Triangular Arbitrage, Algorithmic Trading, Price Discovery, Inventory Risk

JEL Classification: F31, G10, G14

Suggested Citation

Mahmoodzadeh, Soheil and Tseng, Michael and Gencay, Ramazan, Spot Arbitrage in FX Market and Algorithmic Trading: Speed Is Not of the Essence (March 24, 2017). Available at SSRN: https://ssrn.com/abstract=3039407 or http://dx.doi.org/10.2139/ssrn.3039407

Soheil Mahmoodzadeh

University of Cambridge - Faculty of Economics ( email )

Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Michael Tseng (Contact Author)

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
40, Bd du Pont-d'Arve
CH-1015 Lausanne, CH-6900
Switzerland

HOME PAGE: http://sfi.epfl.ch/cms/site/sfi/lang/en/michaeltseng

Ramazan Gencay

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

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