A new wavelet-based ultra-high-frequency analysis of triangular currency arbitrage |
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| Affiliation: | 1. University of Guelph, College of Business and Economics, Department of Economics and Finance, 50 Stone Road East, Guelph, Ontario, N1G 2W1, Canada;2. IESEG School of Management, France;3. LEM-CNRS 9221, Lille, France;4. Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, British Columbia, V5A 1S6, Canada;1. University College Dublin, Ireland;2. City University of Hong Kong and Wilfrid Laurier University, Ireland;3. Dublin City University, Ireland;1. Allegheny College, Department of Economics, Quigley Hall, Box 20, Meadville, PA, 16335, USA;2. Virginia Tech, Department of Economics, Pamplin Hall, Mail Code 0316, Blacksburg, VA, 24061, USA;1. INSEEC School of Business & Economics, 27, Avenue Claude Vellefaux, 75010, Paris, France;2. INSEEC School of Business & Economics, H19, Quai de Bacalan, 33070, Bordeaux, France;1. College of Business, Chosun University, 309 Pilmundaero, Dong-Gu, Gwangju 61452, Republic of Korea;2. College of Business, Korea Advanced Institute of Science and Technology (KAIST), 85 Hoegiro, Dongdaemun-Gu, Seoul 02455, Republic of Korea |
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| Abstract: | We develop a new framework to characterize the dynamics of triangular (three-point) arbitrage in electronic foreign exchange markets. To examine the properties of arbitrage, we propose a wavelet-based regression approach that is robust to estimation errors, measurement bias and persistence. Relying on this wavelet-based (denoising) inference, we consider various liquidity and market risk indicators to predict arbitrage in a unique ultra-high-frequency exchange rate data set. We find strong empirical evidence that limit order book, realized volatility and cross-correlations help forecast triangular arbitrage profits. The estimates are statistically significant and relevant for investors such that on average 80−100 arbitrage opportunities exist with a short duration (100−500 ms) on a daily basis. Our analysis also reveals that triangular arbitrage opportunities are counter-cyclical at ultra-high-frequency levels: arbitrage returns tend to increase (decrease) in periods when volatility risk and correlations are relatively low (high). We show that liquidity-driven microstructure measures, however, appear to be more powerful in exploiting arbitrage profits when compared to market-driven factors. |
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| Keywords: | Foreign exchange markets Triangular arbitrage Limit order book Wavelets G15 G17 F31 |
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