Currency Arbitrage Detection

Volume 5, Issue 5, May – 2020 International Journal of Innovative Science and Research Technology
ISSN No:-2456-2165
Currency Arbitrage Detection

Pranit Mahajan, Vinayak Jadhav, Yagnesh Salian
Sardar Patel Institute of Technology
Electronics and Telecommunication Dept.
Abstract:- Arbitrage is defined as near simultaneous II. RESEARCH METHODOLOGY

purchase and sale of securities or foreign exchange in
different markets in order to profit from price The FOREX, FX or (Foreign Exchange Market) also
discrepancies. Experts believe in the non-existence of known as the currency market has multiple distinctive and
arbitrage in an efficient trade market. Arbitrage results desirable features which makes it a perfect, sensible and
in a high profit in a short duration of time without the advantageous environment for hedging and speculation
need of hedging. Detection plays an important role processes. FOREX is one of the largest, crystal clear and
during an arbitrage as an investor who enters the free flowing market. Because of this in April 2016, the FX
market early, makes the maximum profit. In our market had an estimation of daily trading value equal to 5.1
experiment, A Bellman-Ford based model is used for trillion US Dollars. In contrary to the stock market, the
detecting the mis-pricing. forex market is open and traded continuously. But during
different time frames the trading volume can vary
Keywords:- Arbitrage; Bellman-Ford; foreign exchange; considerably. Particularly the forex market spots a huge rise
hedging. in the trading volume each week on Sunday at 6.00 PM
EST during the opening of the Asian market until Friday at
I. INTRODUCTION 5.00 PM which is the closing time of the American market.
Arbitrage is the trading strategy which earns a risk- The situation like opening multiple Forex markets like
free profit. This profit is earned by using the opportunities Tokyo, Sydney, London and New York can increase the
in the differences of the entities in a well-defined and clear- trading volume rapidly and can be at the greatest. These
cut market or in the various forms of the market. It is the markets are opened simultaneously leading to the
process of earning a profit which is risk-free by considering overlapping. During the London and New York
the various favorable conditions of differences in rate and overlapping nearly 75 percent of the Forex market activities
cost of the same entity regardless the goods are priced occur. The dealer set updates in forex market change at
alone or in identical combinations. Because of such price higher rates and the sets can be executed rather than being
inconsistencies and variations, one can earn a harmless and simply indicative or expressive.
risk-free status in the market and there is a certain
reliability and assurance that he may earn more than his These features are contrary to the equity markets
risk-free return. The Forex market is the highest and most where a huge volume trade can result in significant price
liquid market in the world. A highly liquid market has change and this impact drastically affects the trade. When
insinuates a lower spread, a high volume and turnover. sellers and dealers talk about the FX market, they aim to
profit by anticipating the future flow and direction of the
Traditionally in the Forex market, the Jump-Diffusion market.
factor is largely absent resulting in much tighter bid-ask
spreads. Hence, occasional disparities in the bid-ask prices Arbitrage in the FX market is generally characterized
may lead to a fair amount of risk-free profit. In today's in two categories- First is the arbitrage in FX market
market, price discrepancies can last only for milliseconds or depends on the utilization of price variation between
even for less time. Hence the High Frequencies Traders multiple currency pairs and the another one relies on the
(HFTs) are relying on the highly efficient algorithms and variations from the price relationship between the foreign
the superfast computers to detect such price differences and exchange rate, the forward foreign exchange rate and the
to find the opportunity of arbitrage in the market. respective interest rates on which interest parity must hold
In this paper we are focusing on the implementation of an on. The reason that attracted the large no of marketers and
algorithm called the Bellman-Ford Algorithm to detect such the practitioners from academics towards arbitrage are -
scenarios. large trading volume, variation in the currencies and the
markets, the never ending continuous trading activities and
the decreasing transaction loss.
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ISSN No:-2456-2165
The main insights and contribution to this literature cost caused due to the informational edge. A solid
survey are: computational framework is much required to execute such
critical trades.
 Propose a computational framework to detect and
quantify Arbitrage opportunities. IV. ALGORITHM
 Provide adequate conditions for detection.
The Bellman-Ford Algorithm is an algorithm used to
III. SOLUTION TO THE PROBLEM calculate the shortest path between the two nodes of a
graph. The Dijkstra algorithm is much more efficient but
We can take advantage of potential mis-pricings in the Bellman-Ford here is preferred as it can even handle
Forex market by converting the currencies into a graph and negative edge weights.
using algorithms to traverse it efficiently.
The algorithm calculates the shortest path in the
Looking persistently at these live spot rates is a bottom to top manner. It first calculates the shortest path
daunting task in itself. Time plays an important role in such with the least number of edges involved. After the nth
occasions as arbitrage lasts for a very short duration of time iteration, it calculates the shortest path with n-1 edges
and only opportune investors earn optimal profits. involved. The maximum amount of edges involved in a
Therefore, to overcome this challenge, arbitrage detection path is |V|-1 which is why the loop gets iterated |V|-1
gives you an update every time a mispricing occurs in the times. So, if there’s no negative weight cycle present, then
market. Thus, an investor can enter at a superior position we’ve successfully calculated the shortest path with n being
and can make optimal profits until the arbitrage exists. the maximum number of edges. Further one more iteration
Such problems involving time constraints can be would find the shortest path with n+1 max edges.
effortlessly explicated by computational algorithms and
high-performance systems. The algorithm works on a graph created by the user
and calculates the shortest path. Hence, we create a graph
When an arbitrage is discovered the informed traders of the majorly traded currencies in the forex market.
do not trade vehemently but wait for the liquidity traders to
start. This results in a lot of time being lost to analyze the We constructed a directed graph O (V,E)
extent of the arbitrage leading to the loss of opportunity
Fig 1
The nodes of the graph represent the Major Currencies Hence, we end up with a negative edge weighted
in the Forex market while the edges represent the graph where the negative cycles determine arbitrage. These
conversion rates. The weight of the edge is the natural log negative cycles are detected by Bellman – Ford Shortest
of the respective currency exchange rates. Path algorithm with O(V*E) running complexity.

ISSN No:-2456-2165
V. WORKING OF THE CODE When an arbitrage occurs, the function also calculates
the profit in pips (Percentage in points).
A. Creating the Graph
Creating objects such as nodes and edges with It is preferable to convert the floating point value to
required attributes. The nodes are the primarily used two decimal places and multiply it by 100 and later take the
currencies in the Forex namely USD, EUR, GBP, JPY, negative logarithm of the value obtained. This is advisable
CHF. The nodes can be extended to take any other exotic to abstain finding arbitrage opportunities coalescing to less
currency into consideration. than 1 percent.
B. Detecting Cycle C. Conversions and approximations

The Bellman-Ford algorithm starts looping through The logarithm obtained is used to convert the decimal
the created array of nodes. We take the negative log of the values to integer ones by multiplying them with suitable
live exchange rates to form the weights of the edges. If we powers of 10.
find a path of nodes such that the sum of their weights is
negative, then arbitrage is possible. The Bellman Ford VI. RESULTS
Algorithm helps in detecting negative cycles in O(V*E)
time. The program was successfully able to detect the
negative weight cycles, created by us and then
When an arbitrage opportunity is found, we print the consecutively update them. One important feature of the
cycle using the predecessor chain. If we find an edge which program, the detection of multiple cycles, was also
can be relaxed further, then we can find the path of the successfully tested. It also calculated the profit in pips on
edge. Starting from the source node and traversing the basis of the spot rates at that very moment.
backwards, we intend on finding the source node or any
other node that the predecessor chain has to print the Considering USD as the base currency.
negative weighted cycle.
Fig 2
The first test was done on live FX rates imported from Yahoo Finance and the results were as surmised.
Fig 3

ISSN No:-2456-2165
In the second test, a mispricing was introduced in the
EUR-JPY pair. The value of the currency pair was changed
from 119.17 to 119.89. The code detected the mispricing
and predicted the path of arbitrage and the maximum profit.
VII. FUTURE SCOPE
We would like to work further on this project and

make it fully functional for a live Forex environment so
that we tackle arbitrage opportunities the moment they
come to light.
An arbitrage in the real-world scenario might not be

very drastic as the one introduced above. The program was
also tested for low pip fluctuations, but it still lacks training
on real time data which requires the program to sync with a
trading software.
VIII. CONCLUSION
The program worked perfectly on the data provided

by manual changes in the pricing as well as the past
arbitrage records. It can be used best if run in sync with a
trading platform and can detect arbitrage within a
millisecond. Such implementations are much needed in this
field of work and this project can be further extended to fill
the void.
REFERENCES
[1]. Jacob A. Frenkel and Richard M. Levich.,

“Transaction costs and interest arbitrage: Tranquil
versus turbulent periods”- Journal of Political
Economy, 85(6):1209–1226, 1977.
[2]. B. Awerbuch, A. Bar-Noy and M. Gopal,
"Approximate distributed Bellman-Ford algorithms
(computer network routing)," - IEEE INFOCOM '91
1991, pp. 1206-1213 vol.3.
[3]. Kevin Clinton, “Transactions costs and covered
interest arbitrage,” - Journal of Political Economy,
96(2):358–70, 1988.
[4]. Yukihiro Aiba and Naomichi Hatano., “Triangular
arbitrage in the foreign exchange market.”- Physica A,
pages 174–177, 2004
[5]. Andrei Shleifer, Robert W. Vishny, “Limits of
Arbitrage: The State of the Theory”- Annual Review
of Financial Economics, 2010, 2, 251-275
[6]. Marcelo Perlin, Alfonso Dufour and Chris Books,
“The Drivers of Cross Market Arbitrage
Opportunities: Theory and Evidence for the European
Bond Market” - MPRA Paper 23381, University
Library of Munich, Germany.
[7]. Gagnon, Louis & Andrew Karolyi, "Multi-market
trading and arbitrage," Journal of Financial
Economics, Elsevier, vol. 97(1), pages 53-80, July.

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Volume 5, Issue 5, May – 2020 International Journal of Innovative Science and Research Technology

Currency Arbitrage Detection

Abstract:- Arbitrage is defined as near simultaneous II. RESEARCH METHODOLOGY

IJISRT20MAY047 www.ijisrt.com 311

IJISRT20MAY047 www.ijisrt.com 312

B. Detecting Cycle C. Conversions and approximations

IJISRT20MAY047 www.ijisrt.com 313

VII. FUTURE SCOPE

We would like to work further on this project and

An arbitrage in the real-world scenario might not be

The program worked perfectly on the data provided

[1]. Jacob A. Frenkel and Richard M. Levich.,

IJISRT20MAY047 www.ijisrt.com 314

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