Communication Strategies for Low-Latency Trading

TL;DR

This paper models how traders use coding strategies over noisy, high-speed communication links to exploit latency arbitrage, revealing equilibrium behaviors depending on channel quality.

Contribution

It introduces a game-theoretic model of trading with binary signaling, analyzing equilibrium outcomes based on channel noise and coding strategies.

Findings

Unique Nash equilibrium with ties in low-noise regimes

Multiple equilibria with different winners in high-noise regimes

Trade-offs between reliability and latency in coding schemes

Abstract

The possibility of latency arbitrage in financial markets has led to the deployment of high-speed communication links between distant financial centers. These links are noisy and so there is a need for coding. In this paper, we develop a gametheoretic model of trading behavior where two traders compete to capture latency arbitrage opportunities using binary signalling. Different coding schemes are strategies that trade off between reliability and latency. When one trader has a better channel, the second trader should not compete. With statistically identical channels, we find there are two different regimes of channel noise for which: there is a unique Nash equilibrium yielding ties; and there are two Nash equilibria with different winners.