Trading foreign exchange triplets

DOI10.1137/18M1172089MaRDI QIDQ5123451zbMATH OpenFDO

Authors Álvaro Cartea, Sebastian Jaimungal, Tianyi Jia

Publication date 28 September 2020

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/2004.12011

zbMATH Keywords

ambiguity aversioncurrency pairsexecutionforeign exchangeinventory aversionoptimal liquidation

Mathematics Subject Classification ID

Applications of statistics to economics (62P20) Dynamic programming (90C39) Macroeconomic theory (monetary models, models of taxation) (91B64)

Abstract: We develop the optimal trading strategy for a foreign exchange (FX) broker who must liquidate a large position in an illiquid currency pair. To maximize revenues, the broker considers trading in a currency triplet which consists of the illiquid pair and two other liquid currency pairs. The liquid pairs in the triplet are chosen so that one of the pairs is redundant. The broker is risk-neutral and accounts for model ambiguity in the FX rates to make her strategy robust to model misspecification. When the broker is ambiguity neutral (averse) the trading strategy in each pair is independent (dependent) of the inventory in the other two pairs in the triplet. We employ simulations to illustrate how the robust strategies perform. For a range of ambiguity aversion parameters, we find the mean Profit and Loss (P&L) of the strategy increases and the standard deviation of the P&L decreases as ambiguity aversion increases.

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Cites work

• Algorithmic and high-frequency trading
• Algorithmic trading with model uncertainty
• Execution in an aggregator
• Foreign exchange markets with last look
• Portfolio optimization and stochastic volatility asymptotics
• Portfolio optimization under local-stochastic volatility: coefficient Taylor series approximations and implied Sharpe ratio
• The financial mathematics of market liquidity. From optimal execution to market making

Cited in

(5)

• Double-Execution Strategies Using Path Signatures
• Ternary trades and their codes
• A mean field game between informed traders and a broker
• Unwinding stochastic order flow: when to warehouse trades
• Nash equilibrium between brokers and traders

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