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The impact of latency sensitive trading on high frequency arbitrage opportunities

Alex Frino, Vito Mollica, Robert I. Webb and Shunquan Zhang

Pacific-Basin Finance Journal, 2017, vol. 45, issue C, 91-102

Abstract: This study examines the duration, frequency and profitability of potential high frequency arbitrage strategies between the share price index futures contract and an exchange-traded fund (ETF) written on the S&P/ASX200 constituent securities traded on the Australian Securities Exchange (ASX). We find the frequency and profitability of potential arbitrage opportunities are greater during volatile and high turnover periods—other things equal. We examine the impact of increased competition in high frequency trading (HFT) by identifying the number of ‘co-location connections’ utilized in the ASX's minimum latency liquidity center. We document an increase in the frequency, duration and value (albeit small) of index arbitrage profit opportunities with increased HFT connections. Our results are robust to the inclusion of transaction costs. We conclude that increased HFT activity in markets increases trade execution risk associated with arbitrage (or legging risk) which in turn increases mispricing in markets.

Keywords: High frequency trading; Statistical arbitrage; Co-location; ETF; Futures (search for similar items in EconPapers)
JEL-codes: G14 G18 D40 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:pacfin:v:45:y:2017:i:c:p:91-102