The microscopic relationships between triangular arbitrage and cross-currency correlations in a simple agent based model of foreign exchange markets

Abstract

Foreign exchange rates movements exhibit significant cross-correlations even on very short timescales. The effect of these statistical relationships become evident during extreme market events, such as flash crashes. Although a deep understanding of cross-currency correlations would be clearly beneficial for conceiving more stable and safer foreign exchange markets, the microscopic origins of these interdependencies have not been extensively investigated. This paper introduces an agent-based model which describes the emergence of cross-currency correlations from the interactions between market makers and an arbitrager. The model qualitatively replicates the timescale vs. cross-correlation diagrams observed in real trading data, suggesting that triangular arbitrage plays a primary role in the entanglement of the dynamics of different foreign exchange rates. Furthermore, the model shows how the features of the cross-correlation function between two foreign exchange rates, such as its sign and value, emerge from the interplay between triangular arbitrage and trend-following strategies. In particular, the interaction of these trading strategies favors certain combinations of price trend signs across markets, thus altering the probability of observing two foreign exchange rates drifting in the same or opposite direction. Ultimately, this entangles the dynamics of foreign exchange rate pairs, leading to cross-correlation functions that resemble those observed in real trading data.

Desain Algoritma Dan Implementasi Robot Trading Forex Hedging Dan Averaging

“…Selain itu, literatur tentang metode triangular hedging dan averaging juga menjadi bagian yang tidak terpisahkan untuk penelitian ini. Studi oleh (Ciacci et al, 2020) dan (Xiao & Wu, 2019) mengungkapkan pentingnya manajemen risiko dalam perdagangan mata uang dan strategi hedging yang dapat digunakan untuk melindungi posisi dari fluktuasi pasar. Di sisi lain, penelitian oleh (Stamoulis & Sogiakas, 2017), (Mukherjee & Naka, 2018), (Chen & Chang, 2019), dan (Trivedi & Chauhan, 2022) membahas penggunaan metode averaging dalam perdagangan saham dan forex, yang bertujuan untuk meningkatkan keuntungan dengan merataratakan harga masuk atau keluar dari posisi transaksi.…”

Social physics

“…More recent extensions of the stochastic dealer model help clarify the cross-currency correlations between the US dollar, the Japanese yen, and the Euro [168]. A new type of dealers, who pursue what is known as triangular arbitrage, is introduced into the model.…”