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Just to clarify, since people seem confused on this point, hedge funds add value to society thusly: 1. Companies need to raise capital. 2. Those companies wan

by darawk 7y ago

Just to clarify, since people seem confused on this point, hedge funds add value to society thusly: 1. Companies need to raise capital. 2. Those companies want to raise capital at a rate closest to the true value of shares in their enterprise. 3. In order to do that, the people who buy those shares need to know that they can resell them later, at a similarly efficient price. This is called a "liquidity premium". If your shares cannot be quickly resold at an efficient price, you are incurring a negative liquidity premium. 4. Because of the foregoing, it is extremely valuable to society for markets to price things efficiently. This is a service that needs to be performed by someone. That someone is, for the most part hedge funds. The ideal scenario (which we are tending towards) is that there are a very small number of extremely sophisticated players that keep markets efficient for everyone else. The more money David Shaw makes, the less money there is for other people to make. Which means we need to employ fewer and fewer people in the business of asset price discovery. Price discovery is an important and necessary function, and the fact that there are these few people making tons of money from it is actually kind of a great thing for the world. All those billions David Shaw made represent many millions not going to other people in finance. Which means those minds are freed up to work on other productive things.

tnu_tau12 7y ago
A hedge fund that takes 0 risk and operates through statistical arbitrage or latency advantages is hard to link to capital raising. Liquidity is not a goal in itself the allocation of capital is. If exchanges operated on auctions at every say 15 minutes instead of streaming prices would that matter in the capital allocation process? The real way they make money is your bigger older investment companies get ripped off on trading and this feeds through to the smarter players.
- darawk 7y ago
  > A hedge fund that takes 0 risk and operates through statistical arbitrage or latency advantages is hard to link to capital raising. Liquidity is not a goal in itself the allocation of capital is. Yes, but let's say you are a venture capitalist. Ultimately, you want the company you allocate capital to to IPO, because the IPO is what allows you to recoup your investment later on. The more efficient the market is that your company IPOs into, the more directly your incentives are aligned with investing in good companies. That is why market efficiency, and its counterpart, liquidity, are important. > If exchanges operated on auctions at every say 15 minutes instead of streaming prices would that matter in the capital allocation process? No, that's a perfectly reasonable and good way to operate a market. It's called a "call market", and for most purposes it is in fact strictly better than a continuously trading market. Its primary downside is the lack of immediacy - you have to wait 15 minutes. Of course, you can make that window arbitrarily small, say, every minute. I'm mostly arguing that things like statistical arbitrage, which is what DE Shaw does, are necessary and important. And DE Shaw would continue to operate just fine in a call market. AFAIK they are not primarily HFTs.
qnr 7y ago
Evidence for existence of a (il)liquidity premium in the stock market is very weak. What this means is that the market has been liquid enough for a long, long time. Consider high frequency trading. Does it really matter for capital allocation that you can sell your Google stock for a fair price in 10ms instead of 20ms? There are hundreds of PhDs working on algorithms and billions invested into infrastructure to make those 20ms into 10ms, which I'd argue is a byproduct of how exchanges work and doesn't serve humanity in any way.
- darawk 7y ago
  > Evidence for existence of a (il)liquidity premium in the stock market is very weak. What this means is that the market has been liquid enough for a long, long time. That's not entirely true. Liquidity is often used to mean 'ability to exit your position at the most recently traded price', or something similar. However, i'm using a slightly expanded definition, which means: exit your position at its intrinsic value. The ability to sell your stock for what its actually worth is extremely valuable, and statistical arbitrageurs help you do this. > Consider high frequency trading. Does it really matter for capital allocation that you can sell your Google stock for a fair price in 10ms instead of 20ms? There are hundreds of PhDs working on algorithms and billions invested into infrastructure to make those 20ms into 10ms, which I'd argue is a byproduct of how exchanges work and doesn't serve humanity in any way. Here I agree with you, although I think it's important to understand that a lot of high frequency trading is actually making markets efficient. That is to say, the service being provided by HFTs is truly valuable. What is not super valuable is squeezing out that last marginal millisecond. The energy poured into the last millisecond is indeed deadweight loss, but I think the amount of energy being spent there, while very large in absolute terms, is not so large relevant to the financial industry writ large. So yes, I agree that the competition at the margin in HFT is probably not productive, it is a byproduct of the necessary service that HFTs provide and the dynamics of the environment in which they provide it. I also think that any 'solutions' to the problem of that energy expenditure are likely to make everyone worse off over all, not better. You really want the HFT game to be a winner take all market, in the way that it currently is, precisely because competition is deadweight loss. If you do things like introduce purposeful stochasticity into order submission (for instance), you're going to make the competitive equilibrium more multipolar, so that instead of one dominant firm taking it all, you have a bunch. And that's actually worse for everyone. What we want is basically 1 HFT firm that is the best and does a good enough job that nobody else tries to compete, and earns a reasonable profit for providing the efficiency and liquidity that they do. I think the competitive environment is actually converging on that, even though it may not look that way from the outside.

by darawk 7y ago

tnu_tau12 7y ago

A hedge fund that takes 0 risk and operates through statistical arbitrage or latency advantages is hard to link to capital raising. Liquidity is not a goal in itself the allocation of capital is. If exchanges operated on auctions at every say 15 minutes instead of streaming prices would that matter in the capital allocation process? The real way they make money is your bigger older investment companies get ripped off on trading and this feeds through to the smarter players.

darawk 7y ago
> A hedge fund that takes 0 risk and operates through statistical arbitrage or latency advantages is hard to link to capital raising. Liquidity is not a goal in itself the allocation of capital is. Yes, but let's say you are a venture capitalist. Ultimately, you want the company you allocate capital to to IPO, because the IPO is what allows you to recoup your investment later on. The more efficient the market is that your company IPOs into, the more directly your incentives are aligned with investing in good companies. That is why market efficiency, and its counterpart, liquidity, are important. > If exchanges operated on auctions at every say 15 minutes instead of streaming prices would that matter in the capital allocation process? No, that's a perfectly reasonable and good way to operate a market. It's called a "call market", and for most purposes it is in fact strictly better than a continuously trading market. Its primary downside is the lack of immediacy - you have to wait 15 minutes. Of course, you can make that window arbitrarily small, say, every minute. I'm mostly arguing that things like statistical arbitrage, which is what DE Shaw does, are necessary and important. And DE Shaw would continue to operate just fine in a call market. AFAIK they are not primarily HFTs.

qnr 7y ago

Evidence for existence of a (il)liquidity premium in the stock market is very weak. What this means is that the market has been liquid enough for a long, long time. Consider high frequency trading. Does it really matter for capital allocation that you can sell your Google stock for a fair price in 10ms instead of 20ms? There are hundreds of PhDs working on algorithms and billions invested into infrastructure to make those 20ms into 10ms, which I'd argue is a byproduct of how exchanges work and doesn't serve humanity in any way.

darawk 7y ago
> Evidence for existence of a (il)liquidity premium in the stock market is very weak. What this means is that the market has been liquid enough for a long, long time. That's not entirely true. Liquidity is often used to mean 'ability to exit your position at the most recently traded price', or something similar. However, i'm using a slightly expanded definition, which means: exit your position at its intrinsic value. The ability to sell your stock for what its actually worth is extremely valuable, and statistical arbitrageurs help you do this. > Consider high frequency trading. Does it really matter for capital allocation that you can sell your Google stock for a fair price in 10ms instead of 20ms? There are hundreds of PhDs working on algorithms and billions invested into infrastructure to make those 20ms into 10ms, which I'd argue is a byproduct of how exchanges work and doesn't serve humanity in any way. Here I agree with you, although I think it's important to understand that a lot of high frequency trading is actually making markets efficient. That is to say, the service being provided by HFTs is truly valuable. What is not super valuable is squeezing out that last marginal millisecond. The energy poured into the last millisecond is indeed deadweight loss, but I think the amount of energy being spent there, while very large in absolute terms, is not so large relevant to the financial industry writ large. So yes, I agree that the competition at the margin in HFT is probably not productive, it is a byproduct of the necessary service that HFTs provide and the dynamics of the environment in which they provide it. I also think that any 'solutions' to the problem of that energy expenditure are likely to make everyone worse off over all, not better. You really want the HFT game to be a winner take all market, in the way that it currently is, precisely because competition is deadweight loss. If you do things like introduce purposeful stochasticity into order submission (for instance), you're going to make the competitive equilibrium more multipolar, so that instead of one dominant firm taking it all, you have a bunch. And that's actually worse for everyone. What we want is basically 1 HFT firm that is the best and does a good enough job that nobody else tries to compete, and earns a reasonable profit for providing the efficiency and liquidity that they do. I think the competitive environment is actually converging on that, even though it may not look that way from the outside.