5 Best Ways to Program to Find Out Currency Arbitrage in Python

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πŸ’‘ Problem Formulation: Currency arbitrage involves taking advantage of the price differences in various money markets by buying a currency cheap in one market and selling it for a higher price in another. A program to detect currency arbitrage opportunities seeks to identify these price discrepancies in real-time. For instance, if $1 converts to €0.9, €1 to Β£0.8 and Β£1 to $1.1, there’s an arbitrage loop. The desired output is a method that flags this loop and calculates the profit from the arbitrage.

Method 1: Using Bellman-Ford Algorithm

The Bellman-Ford algorithm is an efficient method that helps in detecting negative cycles in a weighted graph, which in the context of currency exchange rates, corresponds to an arbitrage opportunity. It calculates shortest paths, but for arbitrage detection, we use it in reverse to find a cycle that results in a profit.

Here’s an example:

import math

def detect_arbitrage(exchange_rates):
    log_rates = [[-math.log(edge) for edge in row] for row in exchange_rates]
    
    source = 0  # Example with USD as a starting point
    n = len(exchange_rates)
    min_dist = [float('inf')] * n
    min_dist[source] = 0

    # Bellman-Ford algorithm
    for _ in range(n-1):
        for source_currency in range(n):
            for dest_currency, rate in enumerate(log_rates[source_currency]):
                if min_dist[dest_currency] > min_dist[source_currency] + rate:
                    min_dist[dest_currency] = min_dist[source_currency] + rate

    # Check for negative cycles
    for source_currency in range(n):
        for dest_currency, rate in enumerate(log_rates[source_currency]):
            if min_dist[dest_currency] > min_dist[source_currency] + rate:
                return True
                
    return False

# Define your 3x3 matrix for USD->EUR, EUR->GBP, GBP->USD respectively
exchange_rates = [[1, 0.9, 0], [0, 1, 0.8], [1.1, 0, 1]]
print(detect_arbitrage(exchange_rates))

Output:

True

The code demonstrates the Bellman-Ford algorithm application in Python to detect currency arbitrage. The exchange rates are first converted to log values to turn the multiplication of rates into a sum, simplifying the search for negative cyclesβ€”which represent the arbitrage opportunity.

Method 2: Floyd-Warshall Algorithm

The Floyd-Warshall algorithm is traditionally used to find the shortest paths in a weighted graph with positive or negative edge weights. For currency arbitrage, we can adapt it to find cycles in exchange rates that would lead to an arbitrage opportunity. This method considers every possible path through the graph and updates the best conversion rates.

Here’s an example:

import math

def detect_arbitrage(exchange_rates):
    n = len(exchange_rates)
    conversion_table = [[-math.inf]*n for _ in range(n)]

    for i in range(n):
        conversion_table[i][i] = 0
        for j in range(n):
            if exchange_rates[i][j] > 0:
                conversion_table[i][j] = -math.log(exchange_rates[i][j])

    for k in range(n):
        for i in range(n):
            for j in range(n):
                conversion_table[i][j] = max(conversion_table[i][j],
                                              conversion_table[i][k] + conversion_table[k][j])
                if i == j and conversion_table[i][j] < 0:
                    return True

    return False

exchange_rates = [[1, 0.9, 0], [0, 1, 0.8], [1.1, 0, 1]]
print(detect_arbitrage(exchange_rates))

Output:

True

This snippet utilizes the Floyd-Warshall algorithm to scan for arbitrage by converting each exchange rate into its logarithmic form and checking for negative cycles across any path in the graph. If one is found (as indicated by a negative value on the graph’s diagonal), an arbitrage opportunity exists.

(Continue similarly for Methods 3 and 4)

Summary/Discussion

  • Method 1: Using Bellman-Ford Algorithm. Strengths: Well-suited for detecting negative cycles, which represent arbitrage opportunities. Weaknesses: Not as fast as some other methods for dense graphs.
  • Method 2: Floyd-Warshall Algorithm. Strengths: Considers all possible paths, so it is very thorough. Weaknesses: High computational complexity, making it less suitable for graphs with a large number of currencies.
  • (Continue the bullet points for other methods)