Triangular Arbitrage in the Foreign Exchange Market: Inefficiencies, Technology and Investment Oppor (BOK)
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The recent evolution of an independent cross market, combined with the technological advancements in computerized trading marked the beginning of a new era for the Foreign Exchange Market. With these major changes, triangular arbitrage among currencies has now become a reality in practice rather than just in theory. The book illustrates that the triangular arbitrage (converting from one currency to another, and then to another and back to the original currency) can be very profitable. What is new about this book is that it provides the first direct and precise test of triangular arbitrage based on actual data. Using a comprehensive example in the introductory chapter of the book, the author illustrates both algebraically and graphically what the book is all about. That is, by taking advantage of price discrepancies of a currency in two different markets, a risk free profit can be made. The author is careful to mention that this simple idea of making a risk free profit is not as simple as it may seem. There are several criteria that have to be met, and other factors may have to be considered. In the first chapter, along with the introduction, the author reviews past work on triangular arbitrage. In the second chapter, a comprehensive review of the Foreign Exchange Market is made to increase the reader's understanding of the environment in which triangular arbitrage is conducted and the procedures of computer trading. In chapter three, the author goes on to develop the theory of triangular arbitrage, given a group of five major currencies. The last chapters develop methods and procedures for comprehensive testing of triangular arbitrage. Most of the methods and procedures are original in nature and are based upon actual data. Significant inefficiencies are revealed that usually relate to volatility in the exchange rate.