Trading Foreign Exchange Triplets

SIAM Journal on Financial Mathematics

35 Pages Posted: 18 Oct 2017 Last revised: 27 Apr 2020

See all articles by Álvaro Cartea

Álvaro Cartea

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

Sebastian Jaimungal

University of Toronto - Department of Statistics

Tianyi Jia

University of Toronto

Date Written: October 17, 2017

Abstract

We develop the optimal trading strategy for a Foreign Exchange (FX) broker who must liquidate a large position in an illiquid currency pair. To maximize revenues, the broker considers trading in a currency triplet which consists of the illiquid pair and two other liquid currency pairs. The liquid pairs in the triplet are chosen so that one of the pairs is redundant. The broker is risk-neutral and accounts for model ambiguity in the FX rates to make her strategy robust to model misspecification. When the broker is ambiguity neutral (averse) the trading strategy in each pair is independent (dependent) of the inventory in the other two pairs in the triplet. We employ simulations to illustrate how the robust strategies perform. For a range of ambiguity aversion parameters, we find the mean Profit and Loss (P&L) of the strategy increases and the standard deviation of the P&L decreases as ambiguity aversion increases.

Keywords: Foreign Exchange, Currency Pairs, Optimal Liquidation, Execution, Inventory Aversion, Ambiguity Aversion

Suggested Citation

Cartea, Álvaro and Jaimungal, Sebastian and Jia, Tianyi, Trading Foreign Exchange Triplets (October 17, 2017). SIAM Journal on Financial Mathematics, Available at SSRN: https://ssrn.com/abstract=3054656 or http://dx.doi.org/10.2139/ssrn.3054656

Álvaro Cartea (Contact Author)

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

University of Toronto - Department of Statistics ( email )

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

HOME PAGE: http://http:/sebastian.statistics.utoronto.ca

Tianyi Jia

University of Toronto ( email )

Toronto, Ontario M5S 3G8
Canada

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