A linear programming model to recongnize the arbitrage in the currency market
Date
2013-07-04
Authors
Alupotha, A. G. K. N.
Perera, A. A. I.
Journal Title
Journal ISSN
Volume Title
Publisher
The University of Peradeniya
Abstract
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets. It involves locking in a riskless profit by simultaneously entering into transactions in two or more markets. The price of one country's currency expressed in another country's currency is called the exchange rates. In other words, the rate at which one currency can be exchanged for another.Moreover, exchange rate has long been viewed in monetary literature as an important channel of monetary transmission.In our analysis, exchange rates on July 11, 2012 of the currency markets of the United States Dollar (USD), Euro (EUR), UK Pound (GBP) and Japanese Yen (JPY) have been considered which are being mostly used as dominators in world trade. It is not obvious, but USD-EUR-GBP- JPY-USD conversion actually makes <valuse> per dollar converted and most of the time this scenario can occur regularly for different conversions in different currencies. In our work, we formulated a linear programming model to recognize this arbitrage opportunity and hence arbitrage-free or less transactions can be formed in the currency market. In this model, we make available <valuse> in USD to purchase other currencies and pump through the system. If at the end of the day we get back more than <valuse>, then an arbitrage exists.
According to optimal value of the objective function, there is an arbitrage opportunity if all the transactions are made through the system on that day. Therefore, a number of unnecessary transactions have to be restricted by the governments to make an arbitrage-free or less environment in the currency market. Moreover, deterioration of currency values has been one of the severe reasons to occur arbitrage opportunities. Whereas, the efforts to maintain the most effective exchange rates have a significant impact on domestic inflation.Hence, improving gross domestic product (GDP) and regulating the transfer of foreign currency reserves are the best strategies to maintain an arbitrage-free or less environment as it curbs the deterioration of currency value.
Description
Keywords
Mathematics , Currency market , Linear programming
Citation
Peradeniya University Research Sessions PURSE - 2012, Book of Abstracts, University of Peradeniya, Sri Lanka, Vol. 17, July. 4. 2012 pp. 162