Gauge Invariance, Geometry and Arbitrage

44 Pages Posted: 24 Aug 2009 Last revised: 18 May 2012

See all articles by Samuel Vazquez

Samuel Vazquez

affiliation not provided to SSRN

Simone Farinelli

Core Dynamics GmbH

Date Written: March 2, 2012

Abstract

In this work, we identify the most general measure of arbitrage for any market model governed by Ito processes. We show that our arbitrage measure is invariant under changes of numeraire and equivalent probability. Moreover, such measure has a geometrical interpretation as a gauge connection. The connection has zero curvature if and only if there is no arbitrage. We prove an extension of the Martingale pricing theorem in the case of arbitrage. In our case, the present value of any traded asset is given by the expectation of future cash-flows discounted by a line integral of the gauge connection. We develop simple strategies to measure arbitrage using both simulated and real market data. We find that, within our limited data sample, the market is efficient at time horizons of one day or longer. However, we provide strong evidence for non-zero arbitrage in high frequency intraday data. Such events seem to have a decay time of the order of one minute.

Keywords: Geometric Arbitrage, Arbitrage Pricing, Market Models

JEL Classification: G11, G12, C61

Suggested Citation

Vazquez, Samuel and Farinelli, Simone, Gauge Invariance, Geometry and Arbitrage (March 2, 2012). Available at SSRN: https://ssrn.com/abstract=1458886 or http://dx.doi.org/10.2139/ssrn.1458886

Samuel Vazquez

affiliation not provided to SSRN ( email )

Simone Farinelli (Contact Author)

Core Dynamics GmbH ( email )

Scheuzerstrasse 43
Zurich, 8006
Switzerland