Toxic Arbitrage

Thierry Foucault, Roman Kozhan and Wing Wah Tham

Working Papers from HAL

Abstract: Short lived arbitrage opportunities arise when prices adjust with a lag to new information. They are toxic because they expose dealers to the risk of trading at stale quotes. Hence, theory implies that more frequent toxic arbitrage opportunities and a faster arbitrageurs' response to these should impair liquidity. We provide supporting evidence using data on triangular arbitrage. As predicted, illiquidity is higher on days when the fraction of toxic arbitrage opportunities and arbitrageurs' relative speed are higher. Overall, our findings suggest that the price efficiency gain of high frequency arbitrage comes at the cost of increased adverse selection risk.

Keywords: Arbitrage; Liquidity; Adverse Selection; High Frequency Trading (search for similar items in EconPapers)
Date: 2014-03-15
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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:hal:wpaper:hal-02058262

DOI: 10.2139/ssrn.2409054

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