TY - UNPB

T1 - Limits to Arbitrage in Markets with Stochastic Settlement Latency

AU - Hautsch, Nikolaus

AU - Scheuch, Christoph

AU - Voigt, Stefan

PY - 2018

Y1 - 2018

N2 - Distributed ledger technologies rely on consensus protocols confronting traders with random waiting times until the transfer of ownership is accomplished. This time-consuming settlement process exposes arbitrageurs to price risk and imposes limits to arbitrage. We derive theoretical arbitrage boundaries under general assumptions and show that they increase with expected latency, latency uncertainty, spot volatility, and risk aversion. Using high-frequency data from the Bitcoin network, we estimate arbitrage boundaries due to settlement latency of on average 124 basis points, covering 88% of the observed cross-exchange price differences. Settlement through decentralized systems thus induces non-trivial frictions affecting market efficiency and price formation.

AB - Distributed ledger technologies rely on consensus protocols confronting traders with random waiting times until the transfer of ownership is accomplished. This time-consuming settlement process exposes arbitrageurs to price risk and imposes limits to arbitrage. We derive theoretical arbitrage boundaries under general assumptions and show that they increase with expected latency, latency uncertainty, spot volatility, and risk aversion. Using high-frequency data from the Bitcoin network, we estimate arbitrage boundaries due to settlement latency of on average 124 basis points, covering 88% of the observed cross-exchange price differences. Settlement through decentralized systems thus induces non-trivial frictions affecting market efficiency and price formation.

UR - https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3302159

M3 - Working Paper/Preprint

BT - Limits to Arbitrage in Markets with Stochastic Settlement Latency

ER -