Triangluar Arbitrage

Question

St.USD/AUD = .8 USD/AUD

St,USD/GBP = 1.40 USD/GBP

St,AUD/GBP = 1.80 AUD/GBP

Is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and

compute the profit from this strategy (expressed as a % per unit borrowed). Explain how market

forces move to eliminate triangular arbitrage’s profits.

Answer 1

Yes, Triangular Arbitrage is possible.

Presume you start with 1,000 AUD.

You convert this to USD and receive 800 USD ($1,000 x 0.8)

Then you convert 800USD into 571.43GBP ( 800 / 1.4 )

Then you convert 571.43 GBP into 1,028.57AUD (571.43 x 1.8)

This provides a riskless gain of 2.86%

Intelligent identifiers of Triangular Arbitrage would exploit the opportunity for riskless profit following the steps above (can start with any currency). By arbitragers taking advantage of this riskless profit, they alter the exchange rates in the process, altering rates towards an equilibrium which would eliminate any further possibility for a riskless profit to be made.