The Determinants of a Cross Market Arbitrage Opportunity: Theory and Evidence for the European Bond Market
30 Pages Posted: 7 Jun 2010 Last revised: 26 Jan 2015
Date Written: August 15, 2012
Abstract
This paper examines the determinants of cross-platform arbitrage profits. We develop a structural model that enables us to decompose the likelihood of an arbitrage opportunity into three distinct factors: the fixed cost to trade the opportunity, the level at which one of the platforms delays a price update and the impact of the order flow on the quoted prices (inventory and asymmetric information effects. We then investigate the predictions from the theoretical model for the European Bond market with the estimation of a probit model. Our main finding is that the results found in the empirical part corroborate strongly the predictions from the structural model. The event of a cross market arbitrage opportunity has a certain degree of predictability where an optimal ex ante scenario is represented by a low level of spreads on both platforms, a time of the day close to the end of trading hours and a high volume of trade.
Keywords: Arbitrage Opportunities, Negative Spreads, Market Microstructure, Market Efficiency
JEL Classification: C3, D4, D8, G12
Suggested Citation: Suggested Citation