3 ms·

I think the somewhat sparse academic research on this topic is quite interesting - "The High-Frequency Trading Arms Race: Frequent Batch: Auctions as a Market D

I think the somewhat sparse academic research on this topic is quite interesting - "The High-Frequency Trading Arms Race: Frequent Batch: Auctions as a Market Design Response" by Budish et. al at Chicago (http://faculty.chicagobooth.edu/eric.budish/research/HFT-FrequentBatchAuctions.pdf http://faculty.chicagobooth.edu/eric.budish/research/HFT-Fre...) is one such paper. The key results in this paper are that: - market correlations 'predictably' break down at high-frequency horizons - these correlation breakdowns create a winner-takes-all speed arms race to exploit these opportunities - a theoretical model can be built to explain the investment in speed as a function of these opportunities - this model reduces to the prisoner's dilemma from game theory - the equilibrium state of this model is an environment higher spreads and thinner markets than is socially optimal (without the arms race). It's a very interesting and readable paper, peppered with interesting market observations and theoretical insights.

001sky 13y ago
Along these lines, a note on so-called latency arbitrage: http://web.eecs.umich.edu/srg/wp-content/uploads/2013/02/ec38-wah.pdf http://web.eecs.umich.edu/srg/wp-content/uploads/2013/02/ec3... But in a study last year, University of Michigan professor Michael Wellman and I developed a model across two exchanges. We examined a strategy called latency arbitrage, which utilizes advantages in access and response time to exploit price disparities caused by fragmentation across those dozens of competing venues. HFTs employing latency arbitrage examine current market information to predict immediate price movements, essentially computing the best prices available before the exchange has even had a chance to update its price quote. What we found may be even scarier than Lewis's book-selling punchline: it's not simply a matter of the HFT crowd taking profits away from regular investors. Predatory strategies like latency arbitrage have the potential to reduce trading gains for all market participants – high-frequency traders and Average Joes alike. Their solution was to go to periodic call structure.
- aet 13y ago
  Lets say we go to a call structure. Will there be competitive pressure to go back to a continuous market? For example, lets say you demand all U.S. exchanges go to a call structure. Would there be reason for me to go to London and open up a new continuous market?
  - 001sky 13y ago
    You're illustrating regulatory arbitrage. The answer to that question is always: it depends. Not helpful, I know. But IMHO the issue is not so much here understanding all of the -N- ways to regulate the problem. It's helpful in the first instance to have clear articulations of the problem you need to consider. Market micro-structure is like taxes. It's almost impossible to generalize an answer. An "actual answer" will entail a level of detail and laywers fees that is prohibitive to discuss "for fun" =D. We can apply this critique to all of these academic papers too: they are abstractions and model-markets. The actual particulars of any given order routing...etc. So what is the purpose of this even being posted? It is simply to illustrate how sub-optimal outcomes are possible on a whiteboard. The general takeaway is there is a problem (worsening equilibrium) and a solution (improving one) that relate to tweeking the variables (timing/trade sequencing) discussed upthread. Those are not purely neutral or unrelated to welfare outcomes. It helps to have someone else spell it out sometimes. Both to save the brain damage of spelling it out in HN comments, and also to provide some fresh voices to the dialogue.
- kasey_junk 13y ago
  This is actually a very good paper and I heartily recommend it if you are into wonky market arbitrage. You don't mention it, but they actually recommend a centralized discrete call market. How is that to be implemented? They don't say and they don't count the additional added cost/risk of adding a centralized monopoly player into the market (in fact they completely ignore transaction fees). We moved away from centralized markets in the first place because those costs were non-trivial.

001sky 13y ago

Along these lines, a note on so-called latency arbitrage: http://web.eecs.umich.edu/srg/wp-content/uploads/2013/02/ec38-wah.pdf http://web.eecs.umich.edu/srg/wp-content/uploads/2013/02/ec3... But in a study last year, University of Michigan professor Michael Wellman and I developed a model across two exchanges. We examined a strategy called latency arbitrage, which utilizes advantages in access and response time to exploit price disparities caused by fragmentation across those dozens of competing venues. HFTs employing latency arbitrage examine current market information to predict immediate price movements, essentially computing the best prices available before the exchange has even had a chance to update its price quote. What we found may be even scarier than Lewis's book-selling punchline: it's not simply a matter of the HFT crowd taking profits away from regular investors. Predatory strategies like latency arbitrage have the potential to reduce trading gains for all market participants – high-frequency traders and Average Joes alike. Their solution was to go to periodic call structure.

aet 13y ago
Lets say we go to a call structure. Will there be competitive pressure to go back to a continuous market? For example, lets say you demand all U.S. exchanges go to a call structure. Would there be reason for me to go to London and open up a new continuous market?
- 001sky 13y ago
  You're illustrating regulatory arbitrage. The answer to that question is always: it depends. Not helpful, I know. But IMHO the issue is not so much here understanding all of the -N- ways to regulate the problem. It's helpful in the first instance to have clear articulations of the problem you need to consider. Market micro-structure is like taxes. It's almost impossible to generalize an answer. An "actual answer" will entail a level of detail and laywers fees that is prohibitive to discuss "for fun" =D. We can apply this critique to all of these academic papers too: they are abstractions and model-markets. The actual particulars of any given order routing...etc. So what is the purpose of this even being posted? It is simply to illustrate how sub-optimal outcomes are possible on a whiteboard. The general takeaway is there is a problem (worsening equilibrium) and a solution (improving one) that relate to tweeking the variables (timing/trade sequencing) discussed upthread. Those are not purely neutral or unrelated to welfare outcomes. It helps to have someone else spell it out sometimes. Both to save the brain damage of spelling it out in HN comments, and also to provide some fresh voices to the dialogue.
kasey_junk 13y ago
This is actually a very good paper and I heartily recommend it if you are into wonky market arbitrage. You don't mention it, but they actually recommend a centralized discrete call market. How is that to be implemented? They don't say and they don't count the additional added cost/risk of adding a centralized monopoly player into the market (in fact they completely ignore transaction fees). We moved away from centralized markets in the first place because those costs were non-trivial.