Limits to Arbitrage in Markets With Stochastic Settlement Latency

74 Pages Posted: 2 Jan 2019

See all articles by Nikolaus Hautsch

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research; Center for Financial Studies (CFS)

Christoph Scheuch

Vienna Graduate School of Finance (VGSF); WU (Vienna University of Economics and Business)

Stefan Voigt

WU Wien; Vienna Graduate School of Finance (VGSF)

Date Written: December 3, 2018

Abstract

Distributed ledger technologies rely on consensus protocols confronting traders with random waiting times until the transfer of ownership is accomplished. This time consuming settlement process exposes arbitrageurs to price risk and imposes limits to arbitrage. We derive theoretical arbitrage boundaries under general assumptions and show that they increase with expected latency, latency uncertainty, spot volatility, and risk aversion. Using high-frequency data from the Bitcoin network, we estimate arbitrage boundaries due to settlement latency of on average 124 basis points, covering 88% of the observed cross-exchange price differences. Settlement through decentralized systems thus induces non-trivial frictions affecting market efficiency and price formation.

Keywords: Arbitrage, Settlement Latency, Distributed Ledger, Blockchain

JEL Classification: G00, G10, G14

Suggested Citation

Hautsch, Nikolaus and Scheuch, Christoph and Voigt, Stefan, Limits to Arbitrage in Markets With Stochastic Settlement Latency (December 3, 2018). CFS Working Paper, No. 616, 2018. Available at SSRN: https://ssrn.com/abstract=3302159 or http://dx.doi.org/10.2139/ssrn.3302159

Nikolaus Hautsch (Contact Author)

University of Vienna - Department of Statistics and Operations Research ( email )

Oskar-Morgenstern-Platz 1
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Christoph Scheuch

Vienna Graduate School of Finance (VGSF)

Welthandelsplatz 1
Vienna, A-1020
Austria

HOME PAGE: http://ckscheuch.github.io

WU (Vienna University of Economics and Business) ( email )

Welthandelsplatz 1
Vienna, A-1020
Austria

Stefan Voigt

WU Wien ( email )

Welthandelsplatz 1
Building D4.4.171
Vienna, 1020
Austria

HOME PAGE: http://www.vgsf.ac.at/voigt

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

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