Year: 2016
Type: article
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 faster responses to these opportunities 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. Received March 25, 2015; editorial decision September 21, 2016 by Editor Andrew Karolyi.
Source: Review of Financial Studies
DOI: 10.1093/rfs/hhw103
Authors: Thierry Foucault, Roman Kozhan, Wing Wah Tham
Institutions: HEC Paris, University of Warwick
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: bronze
OpenAlex ID: W4241344282