Toxic Arbitrage

Thierry Foucault and Roman Kozhan ()

No 1040, HEC Research Papers Series from HEC Paris

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 (search for similar items in EconPapers)
JEL-codes: D50 F31 G10 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2014-03-14
New Economics Papers: this item is included in nep-mst
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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http://ssrn.com/abstract=2409054 (application/pdf)

Related works:
Journal Article: Toxic Arbitrage (2017)
Working Paper: Toxic Arbitrage (2014)
Working Paper: Toxic Arbitrage (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ebg:heccah:1040

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