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The Mirage Of Triangular Arbitrage In The Spot Foreign Exchange Market

Author

Listed:
  • 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)

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.

Suggested Citation

  • Daniel J. Fenn & Sam D. Howison & Mark Mcdonald & Stacy Williams & Neil F. Johnson, 2009. "The Mirage Of Triangular Arbitrage In The Spot Foreign Exchange Market," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(08), pages 1105-1123.
    • Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:08:n:s0219024909005609
    DOI: 10.1142/S0219024909005609
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    References listed on IDEAS

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    1. Charles Goodhart & Takatoshi Ito & Richard Payne, 1995. "One Day in June, 1994: A Study of the Working of Reuters 2000-2 Electronic Foreign Exchange Trading System," NBER Technical Working Papers 0179, National Bureau of Economic Research, Inc.
    2. Gençay, Ramazan & Dacorogna, Michel & Muller, Ulrich A. & Pictet, Olivier & Olsen, Richard, 2001. "An Introduction to High-Frequency Finance," Elsevier Monographs, Elsevier, edition 1, number 9780122796715.
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    Cited by:

    1. Mueller, Philippe & Stathopoulos, Andreas & Vedolin, Andrea, 2017. "International correlation risk," Journal of Financial Economics, Elsevier, vol. 126(2), pages 270-299.
    2. Gradojevic, Nikola & Erdemlioglu, Deniz & Gençay, Ramazan, 2020. "A new wavelet-based ultra-high-frequency analysis of triangular currency arbitrage," Economic Modelling, Elsevier, vol. 85(C), pages 57-73.
    3. Wilfredo L. Maldonado & Juan José Egozcue & Vera Pawlowsky‐Glahn, 2021. "No‐arbitrage matrices of exchange rates: Some characterizations," International Journal of Economic Theory, The International Society for Economic Theory, vol. 17(4), pages 375-389, December.
    4. Thierry Foucault & Roman Kozhan & Wing Wah Tham, 2017. "Toxic Arbitrage," The Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1053-1094.
    5. Stefanescu, Razvan & Dumitriu, Ramona, 2016. "Particularitǎţi ale evoluţiei variabilelor financiare [Some particularities of the financial variables evolution]," MPRA Paper 73481, University Library of Munich, Germany, revised 02 Sep 2016.
    6. Alberto Ciacci & Takumi Sueshige & Hideki Takayasu & Kim Christensen & Misako Takayasu, 2020. "The microscopic relationships between triangular arbitrage and cross-currency correlations in a simple agent based model of foreign exchange markets," PLOS ONE, Public Library of Science, vol. 15(6), pages 1-19, June.
    7. Ye Wang & Yan Chen & Haotian Wu & Liyi Zhou & Shuiguang Deng & Roger Wattenhofer, 2021. "Cyclic Arbitrage in Decentralized Exchanges," Papers 2105.02784, arXiv.org, revised Jan 2022.
    8. 'Alvaro Cartea & Sebastian Jaimungal & Tianyi Jia, 2020. "Trading Foreign Exchange Triplets," Papers 2004.12011, arXiv.org.
    9. Alexey Ponomarenko, 2023. "National Currencies in International Settlements: Main Mechanisms," Russian Journal of Money and Finance, Bank of Russia, vol. 82(3), pages 35-47, September.
    10. Marcin Wk{a}torek & Stanis{l}aw Dro.zd.z & Jaros{l}aw Kwapie'n & Ludovico Minati & Pawe{l} O'swik{e}cimka & Marek Stanuszek, 2020. "Multiscale characteristics of the emerging global cryptocurrency market," Papers 2010.15403, arXiv.org, revised Mar 2021.

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