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Toxic Arbitrage

Thierry Foucault, Roman Kozhan () and Wing Wah Tham

No 9925, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: High frequency arbitrage opportunities sometimes 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. We find support for these predictions using high frequency triangular arbitrage opportunities in the FX market. In our 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: Adverse Selection; Arbitrage; High Frequency Trading; Liquidity (search for similar items in EconPapers)
JEL-codes: D50 F31 G10 (search for similar items in EconPapers)
Date: 2014-04
New Economics Papers: this item is included in nep-mst
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Journal Article: Toxic Arbitrage (2017) Downloads
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Working Paper: Toxic Arbitrage (2014)
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