Profitable Arbitrage Opportunities Research Articles

Examining the non-linear stochastic behavior of the European energy market: evidence from nonlinear unit root tests

ABSTRACT Stock market efficiency has been one of the most investigated topics of the last century. Knowing the efficiency of a market has major implications for both investors and policymakers, as a perfectly efficient market eliminates any arbitrage opportunity and the possibility of actually beating the market. For this reason, this study aims to examine the weak-form market efficiency of the European energy markets using linear and nonlinear unit root tests for the period covering February 2012 to April 2021. The results indicated that while the Augmented Dickey–Fuller test captured the stationarity in only Austria’s Oil, and Gas index, using nonlinear tests showed stationarity in 17 of the 20 indices tested. Overall, the European Energy Market can be considered inefficient under the weak form of the Efficient Market Hypothesis. Therefore, there is an indication of profitable arbitrage opportunities among energy stocks. Signs of stationarity also suggest that shocks to energy stocks will have temporary effects. Energy markets of Austria, Finland, France, Greece, Italy, Netherlands, Russia, Spain, Sweden, and the United Kingdom, for this reason, could benefit from policy changes to support increased information flow to achieve more transparency and utilize better trading technologies.

Is China's carbon trading market efficient? Evidence from emissions trading scheme pilots

This paper examines whether the efficient market hypothesis (EMH) holds in the Chinese carbon trading pilots by employing the Sequential Panel Selection Method (SPSM) which is combined with the Panel KSS unit root tests with Fourier function. This approach serves as a highly valid tool in controlling for cross-sectional dependence and heterogeneity as well as structural shifts and nonlinearities. In virtue of the SPSM, the paper could divide the whole panel into two groups and clearly identify which and how many series belong to stationary or non-stationary group. The results show that carbon prices follow mean reversion process, indicating that the EMH does not hold in the Chinese emissions trading scheme (ETS), with the exception of Shanghai. The inefficiency of ETS pilots can be explained by irrational behaviors, poor information transparency, imperfect market mechanism and transaction costs. Accordingly, the failure of EMH implies the existence of profitable arbitrage opportunities for market participants. To establish the nationwide ETS market, policy lessons should be learned from Shanghai as this pilot is demonstrated to be an efficient market. Additionally, policymakers should improve the trading information disclosure system and formulate uniform guidelines, which is propitious to enhance market efficiency of the Chinese ETS.

Real-Time Coordination of Transmission and Distribution Networks via Nash Bargaining Solution

The two-settlement electricity markets are widely accepted. In current practice, the markets are cleared based on locational marginal prices. However, this market clearing scheme leaves arbitrage opportunities between day-ahead and real-time markets for strategic distribution system operators (DSOs). They can submit biased bids from their actual load forecasts in the day-ahead market for additional benefits. Worse still, due to the high penetration of distributed energy resources, the impact of such strategic behaviors becomes increasingly severe as the uncertainties in DSOs’ load forecasts increase. In this paper, we first identify the profitable arbitrage opportunities of DSOs and the impact of uncertainties by a simplified analytical model. We then propose a Nash bargaining solution based market clearing scheme for real-time coordination between the transmission system operator and the DSOs. This scheme guarantees the fairness of net-benefit allocation among all the operators, prevents the strategic behaviors of DSOs, and helps the consistency between day-ahead commitment and real-time operation. Finally, we validate the effectiveness of the proposed scheme on both a simplified system and a practical power system testbed.

The inconvenience yield of carbon futures

Since 2009, the European Carbon Futures Market has been in a permanent contango situation that is characterised by systematic negative convenience yields that allow investors to exploit profitable arbitrage opportunities. The objective of this paper is to analyse the possible drivers of these negative convenience yields. Our empirical results indicate that although some carbon trading variables are behind this contango situation, the carbon inconvenience yield is better explained if other financial markets and variables are considered, suggesting a financialization of the European Carbon Futures Market.

The relationship between arbitrage in futures and spot markets and Bitcoin price movements: Evidence from the Bitcoin markets

AbstractWe examine how investors arbitrage the Bitcoin spot and futures markets. Using intraday data of the Chicago Board Options Exchange, we reconstruct the actual arbitrage condition that investors confront. We find that there are few arbitrage profit opportunities in “normal” markets, but large arbitrage profit opportunities arise during Bitcoin market “crashes.”

Bitcoin arbitrage

We investigate arbitrage at four decentralized bitcoin exchanges that contribute to calculation of the index serving as the underlying price for the CME bitcoin futures. Deviations from price parity are much higher on average, more volatile, exhibit persistency and occasionally reach fairly large extremes during the 2016–2017 period, becoming economically small, much less volatile and sporadic afterwards. We design an arbitrage investment strategy based on the premise of convergence to parity and account for transaction costs. Profitable arbitrage opportunities have become sparse and scarce since 2018.

Decentralized Efficiency? Arbitrage in Bitcoin Markets

Using tick-level bitcoin data from February 2013 through April 2018, we show substantial arbitrage spreads between global bitcoin markets. Spreads follow multiple consistent patterns. Minimum and maximum prices show significant clustering. Spreads increase during the early hours of a day (according to coordinated universal time), when new exchanges enter markets, and following bitcoin heists and hacks. The full year 2017 and the first quarter of 2018 each had exploitable net arbitrage profit opportunities of at least USD380 million that smart money failed to capture. Based on long-term analyses, we also found that bitcoin market inefficiency has increased over time.

Execution Risk and Arbitrage Opportunities in the Foreign Exchange Markets

With the high-frequency data of firm quotes in the transaction platform of foreign exchanges, arbitrage profit opportunities—in the forms of a negative bid-ask spread of a currency pair and triangular transactions involving three currency pairs—can be detected to emerge and disappear in the matter of seconds. The frequency and duration of such arbitrage opportunities have declined over time, most likely due to the emergence of algorithmic trading. When a human trader detects such an arbitrage opportunity and places orders for multiple transactions—two in negative spreads and three in triangular arbitrage—there is no guarantee all of those orders are fulfilled in a fraction of one second. Thus, the arbitrageur has to consider execution risk, when he/she/it detects the emergence of such an opportunity. The novelty of this paper is to show that those arbitrage opportunities were exploitable and executable, before the mid-2000s, even considering the transactions costs and execution risk. After many algorithmic computers were allowed to be connected directly to the EBS transaction platform in the mid-2000s, the frequency of free lunch cases has declined and probabilities of successful executions of all legs for arbitrage declined. We calculate the change in the expected profit of an attempt to execute necessary transactions to reap benefits from arbitrage opportunity.

Exploring Contrarian Degree in the Trading Behavior of China's Stock Market

We study the contrarian and trend-following trading behavior of market timers in China's stock market. Using a network model to describe interpersonal relationships, we deploy the Ising model to capture trading strategies for both contrarians and followers. With empirical data of China's stock market, we find that contrarians account for 12-14% of trading volume. We further compare the performance of contrarians and followers and demonstrate the inefficiency of China's stock market where timing arbitrage exists. We highlight the fact that while the actual return sequence is driven by followers, the contrarians seize a lot of profitable arbitrage opportunities.

The behaviour of betting and currency markets on the night of the EU referendum

We study the behaviours of the Betfair betting market and the sterling/dollar exchange rate (futures price) during 24 June 2016, the night of the EU referendum. We investigate how the two markets responded to the announcement of the voting results by employing a Bayesian updating methodology to update prior opinion about the likelihood of the final outcome of the vote. We then relate the voting model to the real-time evolution of the market-determined prices as the results were announced. We find that, although both markets appear to be inefficient in absorbing the new information contained in the vote outcomes, the betting market seems less inefficient than the FX market. The different rates of convergence to the fundamental value between the two markets lead to highly profitable arbitrage opportunities.

An analysis of the arbitrage efficiency of the Chinese SSE 50ETF options market

This paper analyzes the arbitrage efficiency of the first Chinese 50ETF option contracts traded on the Shanghai Stock Exchange (SSE). Put-call parity arbitrage, box spread arbitrage, and boundary arbitrage strategies are used to test the efficiency of the Chinese SSE 50ETF options market during the sample period (February 2015–April 2017). Furthermore, various transaction costs – such as transaction fees, market-impact costs, bid-ask spreads, margins and capital opportunity costs – and different scenarios are included in the arbitrage tests. The empirical results reveal that arbitrage opportunities are existing but infrequent when transaction costs are considered. In terms of box spread arbitrage and boundary arbitrage strategies, the percentage of profitable arbitrage opportunities is low. In terms of the put-call parity arbitrage strategy, the results held most of the time, and profitable arbitrage opportunities appear at times of great fluctuation in the Chinese stock market from May to September 2015. Further analysis of arbitrage opportunities in terms of both option moneyness and maturity show that more arbitrage opportunities appear in options with comparatively poor liquidity and inactive trading. Overall, there is no strong evidence found against the Chinese SSE 50ETF options market, although arbitrage opportunities exist infrequently.

Do Investors Arbitrage in the Cryptocurrency Market? Evidence from the Bitcoin Futures Market

We examine how investors arbitrage the Bitcoin spot and futures markets. Using intraday data of the Chicago Board Options Exchange (CBOE), we reconstruct the actual arbitrage condition that investors confront. We find that there are few arbitrage profit opportunities in “normal” markets, but large arbitrage profit opportunities arise during Bitcoin market “crashes.

The Behaviour of Betting and Currency Markets on the Night of the EU Referendum

We study the behaviour of the Betfair betting market and the sterling/dollar exchange rate (futures price) during 24 June 2016, the night of the EU referendum. We investigate how the two markets responded to the announcement of the voting results. We employ a Bayesian updating methodology to update prior opinion about the likelihood of the final outcome of the vote. We then relate the voting model to the real time evolution of the market determined prices. We find that although both markets appear to be inefficient in absorbing the new information contained in vote outcomes, the betting market is apparently less inefficient than the FX market. The different rates of convergence to fundamental value between the two markets leads to highly profitable arbitrage opportunities.

Arbitrage Opportunities for Cross-Listed Stocks: Evidence from Russia

We study alternative arbitrage strategies for stocks of Russian companies and the corresponding depository receipts issued in European exchanges. We describe schemes of arbitrage strategies with and without conversion, estimate all related transaction costs and compare the net returns. We find significantly profitable arbitrage opportunities. The long-short strategies without conversion, although being risky, generate returns which are about twice as high as the returns to the arbitrage strategies with conversion. Arbitrage opportunities are higher for less liquid pairs and in situations when the depository receipts are underpriced. Although the arbitrage returns have declined over time, they are still positive and higher than the market returns. Low liquidity of Russian depository receipts on European exchanges is a significant barrier to arbitrage.

The impact of latency sensitive trading on high frequency arbitrage opportunities

This study examines the duration, frequency and profitability of potential high frequency arbitrage strategies between the share price index futures contract and an exchange-traded fund (ETF) written on the S&P/ASX200 constituent securities traded on the Australian Securities Exchange (ASX). We find the frequency and profitability of potential arbitrage opportunities are greater during volatile and high turnover periods—other things equal. We examine the impact of increased competition in high frequency trading (HFT) by identifying the number of ‘co-location connections’ utilized in the ASX's minimum latency liquidity center. We document an increase in the frequency, duration and value (albeit small) of index arbitrage profit opportunities with increased HFT connections. Our results are robust to the inclusion of transaction costs. We conclude that increased HFT activity in markets increases trade execution risk associated with arbitrage (or legging risk) which in turn increases mispricing in markets.

The Impact of Latency Sensitive Trading on High Frequency Arbitrage Opportunities

Classical economic theory suggests that excess returns should be competed away as new participants enter the market. This is especially true for the profits from riskless arbitrage. Yet, there is conflicting evidence in the financial economic literature over whether high frequency trading (HFT) profits, in general, (Baron et al [2012]) and arbitrage profits, in particular (Budish et al [2013] and Chaboud et al [2013]), decline as high frequency or other algorithmic trading increases. There are important public policy implications for market microstructure and the social value of investments by HFT firms in being faster if arbitrage profit opportunities persist (in the absence of limits to arbitrage). There are several different strategies that high frequency and other latency sensitive traders engage in. These include: index arbitrage; spread arbitrage/market making; and correlated arbitrage among others. This study focuses on only one - index arbitrage. Specifically, it examines whether the duration, frequency and profitability of potential arbitrage opportunities between the Australian Securities Exchange (ASX) Share Price Index (SPI) futures contract and the exchange traded fund (ETF), STW, have changed as the number of HFT firms (or intensity of HFT activity) has increased, since the ASX’s introduction of co-location services in February 2012. In addition, we use estimated potential arbitrage profits and compare them to the cost of being co-located to determine the value of minimum latency. Not surprisingly, we find the frequency and profitability of potential arbitrage opportunities are greater during volatile and high turnover periods - other things equal. We examine the increased competition in high frequency trading by identifying the number of ‘cabinets’ co-located in the ASX’s liquidity center. With increased HFT connections, we observe increasing value, frequency and duration of index arbitrage profit opportunities. Our results are robust to the inclusion of transaction costs. We conclude that the activity of disruptive HFT outweighs the activity of index arbitrage HFTs.

Testing for statistical arbitrage in credit derivatives markets

Abstract This paper studies statistical arbitrage opportunities in credit derivatives markets using strategies combining Credit Default Swaps (CDSs) and Asset Swap Packages (ASPs) by means of an improved statistical arbitrage test. Using four different databases (GFI, Reuters, CMA, and J.P. Morgan) from 2005 to 2009, we find persistent mispricings between the CDS and ASP spreads of individual firms, which should be priced similarly, before and during the 2007–2009 financial crisis. These mispricings are more frequent in low credit quality bonds and appear to offer arbitrage opportunities. We also aggregate the firms' CDS and ASP in a portfolio and still find persistent deviations, mainly in the lower rated bonds. In aggregate terms the deviations from the parity relation can be explained from systematic factors such as financing costs, counterparty risk, and global risk. However, after considering realistic estimations of funding and trading costs, all these mispricings are unlikely to provide profitable arbitrage opportunities.

Indian Capital Control Liberalization: Evidence from NDF Markets

The Indian government has taken a number of incremental measures to liberalize legal and administrative impediments to international capital movements in recent years. This paper analyzes the extent to which the effectiveness of capital controls in India, measured by the domestic less net foreign interest rate differential (deviations from covered interest rate parity) have changed over time. We utilize the 3-month offshore non-deliverable forward (NDF) market to measure the effective foreign interest rate (implied NDF yield). Using the self exciting threshold autoregression (SETAR) methodology, we estimate a no-arbitrage band width whose boundaries are determined by transactions costs and capital controls. Inside of the bands, small deviations from CIP follow a random walk process. Outside the bands, profitable arbitrage opportunities exist and we estimate an adjustment process back towards the boundaries. We allow for asymmetric boundaries and asymmetric speeds of adjustment (above and below the band thresholds), which may vary depending on how arbitrage activity is constrained by capital controls. We test for structural breaks, identify three distinct periods, and estimate these parameters over each sub-sample in order to capture the de facto effect of changes in capital controls over time. We find that de facto capital control barriers: (1) are asymmetric over inflows and outflows, (2) have changed over time from primarily restricting outflows to effectively restricting inflows (measured by band widths and positions); (3) arbitrage activity closes deviations from CIP when the threshold boundaries are exceeded in all sub-samples. In recent years, capital controls have been more symmetric over capital inflows and outflows and the deviations from CIP outside the boundaries are closed more quickly.

Valuing put options on single stock futures: Does the put-call parity relationship hold in the South African derivatives market?

This study attempts to determine whether mispricing of options on single stock futures is present in the South African derivatives market. The valuation of options on single stock futures is considered through the put-call parity relationship. The theoretical fair values obtained, are compared to the actual market values over a period of three years, that is, from 2009 to 2011. Only put options are considered in this research.The results show that arbitrage put option opportunities do present themselves for the chosen shares. The actual put options were found to be underpriced in 5 out of 6 (83%) of the cases considered over the evaluation periods chosen. The mispricing was significant for both the BHP Billiton options with 100% and in the case of Sasol options (66%) of the time. Whether profitable arbitrage opportunities is possible, will depend on the magnitude of the mispricing and the transaction fees payable. Further, more extensive research may help identify tendencies which may be of use for the formulation of arbitrage strategies.

Mispricing in Stock Index Futures Markets – the Case of Greece

This study investigates the pricing efficiency of FTSE/ATHEX-20 index futures contracts and examines whether arbitrage profits exist in the Greek market. By comparing ex-post mispricing with round-trip total transaction costs faced by different groups of market participants, the empirical investigation suggests that profitable arbitrage opportunities are likely to be common in the Athens Exchange. The current paper also documents and tests the factors that determine the occurrence and the magnitude of the arbitrage opportunities in the Greek futures market. The findings suggest that variables, such as futures maturity, dividends, volatility, liquidity and short-selling restrictions, explain effectively the cash-futures mispricing.