Robust FX Triplet Trading for Liquidating Illiquid Currency Positions

Summary

This work develops a trading strategy for an FX broker liquidating a large position in an illiquid currency pair. The broker trades a triplet comprising that pair and two liquid pairs, selected so that one pair is redundant. The setup is risk-neutral but accounts for ambiguity in exchange-rate models to make liquidation decisions robust to misspecification.

The strategy's inventory dependence changes with ambiguity preferences: under ambiguity neutrality, each pair's trading decision is independent of inventory in the other two pairs, while ambiguity aversion makes the decisions interdependent. Simulations illustrate the robust strategies and report that, across a range of ambiguity-aversion parameters, mean P&L rises and P&L standard deviation falls as aversion increases. These are simulation findings for the described model; the supplied summary does not specify assumptions, markets, or out-of-sample evidence, so it does not establish real-world performance.

Key ideas

• A broker can liquidate an illiquid FX position by trading it alongside two liquid currency pairs.
• The liquid pairs are selected so that one pair in the triplet is redundant.
• Ambiguity-neutral trading decisions are independent across pairs' inventories, while ambiguity aversion creates dependence.
• Simulations show higher mean P&L and lower P&L variability as ambiguity aversion rises across a range of parameters.

Tags

# Trading Foreign Exchange Triplets


# Trading Foreign Exchange Triplets









We develop the optimal trading strategy for a foreign exchange (FX) broker who must liquidate a large position in an illiquid currency pair. To maximize revenues, the broker considers trading in a currency triplet which consists of the illiquid pair and two other liquid currency pairs. The liquid pairs in the triplet are chosen so that one of the pairs is redundant. The broker is risk-neutral and accounts for model ambiguity in the FX rates to make her strategy robust to model misspecification. When the broker is ambiguity neutral (averse) the trading strategy in each pair is independent (dependent) of the inventory in the other two pairs in the triplet. We employ simulations to illustrate how the robust strategies perform. For a range of ambiguity aversion parameters, we find the mean Profit and Loss (P&L) of the strategy increases and the standard deviation of the P&L decreases as ambiguity aversion increases.

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