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The Mirage Of Triangular Arbitrage In The Spot Foreign Exchange Market

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Author Info

  • DANIEL J. FENN

    ()
    (Mathematical and Computational Finance Group, Mathematical Institute, University of Oxford, Oxford OX1 3LB, UK)

  • SAM D. HOWISON

    ()
    (Mathematical and Computational Finance Group, Mathematical Institute, University of Oxford, Oxford OX1 3LB, UK)

  • MARK MCDONALD

    ()
    (FX Research and Trading Group, HSBC Bank, 8 Canada Square, London E14 5HQ, UK)

  • STACY WILLIAMS

    ()
    (FX Research and Trading Group, HSBC Bank, 8 Canada Square, London E14 5HQ, UK)

  • NEIL F. JOHNSON

    ()
    (Physics Department, University of Miami, Coral Gables, Florida 33146, USA)

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    Abstract

    We investigate triangular arbitrage within the spot foreign exchange market using high-frequency executable prices. We show that triangular arbitrage opportunities do exist, but that most have short durations and small magnitudes. We find intra-day variations in the number and length of arbitrage opportunities, with larger numbers of opportunities with shorter mean durations occurring during more liquid hours. We demonstrate further that the number of arbitrage opportunities has decreased in recent years, implying a corresponding increase in pricing efficiency. Using trading simulations, we show that a trader would need to beat other market participants to an unfeasibly large proportion of arbitrage prices to profit from triangular arbitrage over a prolonged period of time. Our results suggest that the foreign exchange market is internally self-consistent and provide a limited verification of market efficiency.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 12 (2009)
    Issue (Month): 08 ()
    Pages: 1105-1123

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    Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:08:p:1105-1123

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    Related research

    Keywords: Foreign exchange market; triangular arbitrage;

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