Spot Arbitrage in FX Market and Algorithmic Trading: Speed is Not of the Essence

Abstract

We examine the role of algorithmic traders as arbitrageurs and their impact on price efficiency in the
interdealer foreign exchange market. Algorithmic traders do not improve price efficiency by detecting and exploiting mis-priced currency pairs. To the contrary, algorithmic traders contribute to the creation of arbitrage opportunities as a byproduct of intensified competition among liquidity providers. On the other hand, their market making activity also amplifies microstructure barriers to the creation of arbitrage opportunities, which explains the reduced occurrence of arbitrage opportunities.

Keywords: Foreign Exchange Market, Triangular Arbitrage, Algorithmic Trading, Price Discovery, Inventory Risk

JEL Classification: F31, G10, G14