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Foreign Exchange Markets with Last Look

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  • Alvaro Cartea
  • Sebastian Jaimungal
  • Jamie Walton

Abstract

We examine the Foreign Exchange (FX) spot price spreads with and without Last Look on the transaction. We assume that brokers are risk-neutral and they quote spreads so that losses to latency arbitrageurs (LAs) are recovered from other traders in the FX market. These losses are reduced if the broker can reject, ex-post, loss-making trades by enforcing the Last Look option which is a feature of some trading venues in FX markets. For a given rejection threshold the risk-neutral broker quotes a spread to the market so that her expected profits are zero. When there is only one venue, we find that the Last Look option reduces quoted spreads. If there are two venues we show that the market reaches an equilibrium where traders have no incentive to migrate. The equilibrium can be reached with both venues coexisting, or with only one venue surviving. Moreover, when one venue enforces Last Look and the other one does not, counterintuitively, it may be the case that the Last Look venue quotes larger spreads.

Suggested Citation

  • Alvaro Cartea & Sebastian Jaimungal & Jamie Walton, 2018. "Foreign Exchange Markets with Last Look," Papers 1806.04460, arXiv.org.
    • Handle: RePEc:arx:papers:1806.04460
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    File URL: http://arxiv.org/pdf/1806.04460
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    References listed on IDEAS

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    1. Sanford J. Grossman & Merton H. Miller, 1988. "Liquidity and Market Structure," NBER Working Papers 2641, National Bureau of Economic Research, Inc.
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    3. repec:bla:jfinan:v:43:y:1988:i:3:p:617-37 is not listed on IDEAS
    4. Oomen, Roel, 2017. "Execution in an aggregator," LSE Research Online Documents on Economics 67454, London School of Economics and Political Science, LSE Library.
    5. Roel Oomen, 2017. "Execution in an aggregator," Quantitative Finance, Taylor & Francis Journals, vol. 17(3), pages 383-404, March.
    6. de Jong,Frank & Rindi,Barbara, 2009. "The Microstructure of Financial Markets," Cambridge Books, Cambridge University Press, number 9780521687270, September.
    7. Copeland, Thomas E & Galai, Dan, 1983. "Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 38(5), pages 1457-1469, December.
    8. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
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    Cited by:

    1. 'Alvaro Cartea & Sebastian Jaimungal & Leandro S'anchez-Betancourt, 2019. "Latency and Liquidity Risk," Papers 1908.03281, arXiv.org.

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