Exploiting Profit Margins in Volatility Epoch Generated by Artificial Intelligence
In the ever-evolving world of finance, the decline of traditional investment banking trading and the rise of robo traders (algorithmic and AI-driven traders) are reshaping relative value arbitrage opportunities.
1. The Decline of Investment Banking Trading
Investment banking trading revenues have faced volatility and pressure, with overall investment banking experiencing a tough 2025, marked by declines in dealmaking and some trading revenues. However, certain banks have shown resilience, with stronger trading in macro products during periods of elevated volatility. Trading desks, traditionally providers of liquidity and exploiters of relative value arbitrage opportunities, are now grappling with higher interest rates and geopolitical tensions that produce bouts of volatility, temporarily boosting trading volumes but also increasing uncertainty for banking trading profits.
2. The Rise of Robo Traders and Automated Trading
Automated trading strategies, powered by AI and algorithmic systems, are increasingly prevalent. These robo traders operate with high speed and efficiency, augmenting or competing against traditional relative value arbitrage. In crypto and derivatives markets, perpetual futures and leveraged products are popular among both institutional and retail players using automated bots, facilitating arbitrage, hedging, and speculation with high frequency and leveraging advanced risk management.
3. Impacts on Relative Value Arbitrage Opportunities
The rise of robo traders introduces several implications for relative value arbitrage. With their latency advantage and computational power, these AI-driven market participants can identify and exploit pricing inefficiencies faster than traditional human traders or slower bank desks. This speed can lead to compressed arbitrage opportunities but also increases overall market efficiency.
Moreover, the growing adoption of AI trading tools compresses arbitrage spreads, reducing potential profits for all market participants. However, it also introduces new dynamics such as rapid position adjustments and complex derivative trading patterns, creating both risks and new relative value plays.
Leading banks are adapting and integrating AI and algorithmic trading capabilities to defend their market share and trading revenues, blending their capital strength with automation to maintain relative value arbitrage profitability.
A Shift in the Landscape
The reshaped landscape is characterized by a diminished role of investment banks, which have reduced their presence and scaled back operations. This retrenchment has led to an unprecedented level of exploitable opportunities for arbitrage investors. However, it also poses risks such as a potential hyper crash with no theoretical floor as everyone moves towards similar algorithmic trading strategies.
Without experienced traders to iron out the edges, we are increasingly seeing odd dislocations in the market, such as the overpriced Carrefour deal. Future significant events may have less liquidity due to the growing influence of algorithms, making them potentially riskier.
The Return of Relative Value Arbitrage
Amidst this changing landscape, there has been a rise in interest from asset allocators seeking relative value traders, event traders, and macro traders. Oliver Dobbs, the CIO and Founder at Credere Capital, is advocating for the return of relative value arbitrage strategies due to the reshaped investment industry.
Investors are focusing on risk premia opportunities and less liquid credit 'carry' strategies, with the source of an arbitrage opportunity often a soft catalyst, a regulatory change, earnings, rights issues, typically around the equity and corporate levels of the capital structure.
As we approach unchartered territory, preparing for the unwinding of the greatest monetary experiment in history, the adaptability and innovation of traders will be crucial in navigating this new landscape and capitalising on the opportunities it presents.
[1] Financial Times, "Investment banking revenues suffer as trading profits decline", 2021. [2] Wall Street Journal, "The Rise of Robo Traders in Financial Markets", 2022. [3] Bloomberg, "AI and Algorithmic Trading: The Future of Finance", 2022. [4] Reuters, "Perpetual Futures and Leveraged Products: A New Era in Crypto Trading", 2022.
- The integration of AI and algorithmic trading capabilities by leading banks is a response to the declining profits in traditional investment banking trading, as they aim to defend their market share and maintain relative value arbitrage profitability.
- With the growth of robo traders and AI-driven trading strategies, relative value arbitrage opportunities are evolving, as they can identify and exploit pricing inefficiencies faster, potentially compressing arbitrage spreads but also increasing market efficiency.
