Foreign Exchange Hints - Foreign Exchange Arbitrage Hints...

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Foreign Exchange Arbitrage – Hints To build the LP think of the simplest arbitrage opportunity, one involving only 2 exchange rates, for example $ and Euro. In this case, a “roundtrip” transaction would yield more $ than we start off with. The decision variables are how much money I trade from one currency to a different currency. In this context we have 2 variables for any bilateral exchange: Q($, ) as the variable for the quantity of $ we exchange into Euro ( ). Q( ,$) as the variable for the quantity of Euro we exchange into $. These two variables are not the same, and should not be equal to each other. Start off with one unit it each currency. To model the transactions, consider each currency as a distribution node in a transportation LP . If an arbitrage opportunity exists we could make money when the inflow to the currency is greater than the outflow . In other words: Inflow - Outflow 0 This constraint assures that we are not “creating” any money. If there isn’t an arbitrage
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This note was uploaded on 03/06/2011 for the course OSCM 230 taught by Professor Dong during the Spring '08 term at Washington University in St. Louis.

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