Real-Time Detection of Local No-Arbitrage Violations

Author:

Torben G. Andersen, Viktor Todorov, Bo Zhou

Keyword:

Economics, Econometrics, Econometrics (econ.EM)

journal:

date:

2023-07-19 16:00:00

Abstract

This paper focuses on the task of detecting local episodes involving violation of the standard It\^o semimartingale assumption for financial asset prices in real time that might induce arbitrage opportunities. Our proposed detectors, defined as stopping rules, are applied sequentially to continually incoming high-frequency data. We show that they are asymptotically exponentially distributed in the absence of Ito semimartingale violations. On the other hand, when a violation occurs, we can achieve immediate detection under infill asymptotics. A Monte Carlo study demonstrates that the asymptotic results provide a good approximation to the finite-sample behavior of the sequential detectors. An empirical application to S&P 500 index futures data corroborates the effectiveness of our detectors in swiftly identifying the emergence of an extreme return persistence episode in real time.

PDF: Real-Time Detection of Local No-Arbitrage Violations.pdf