Les Cahiers de Recherche - HEC Paris
() and Roman Kozhan
Abstract: High frequency arbitrage opportunities arise when the
price of one asset follows, with a lag, changes in the value of another
related asset due to information arrival. These opportunities are toxic
because they expose liquidity suppliers to the risk of being picked off by
arbitrageurs. Hence, more frequent toxic arbitrage opportunities and a
faster arbitrageurs' response to these opportunities impair liquidity. The
authors find support for these predictions using high frequency triangular
arbitrage opportunities in the FX market. In their sample, a 1% increase in
the likelihood that a toxic arbitrage terminates with an arbitrageur's
trade (rather than a quote update) raises bid-ask spreads by about 4%.
Keywords: Arbitrage; Adverse Selection; Liquidity; High Frequency Trading; (follow links to similar papers)
JEL-Codes: D50; F31; G10; (follow links to similar papers)
61 pages, March 14, 2014
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