Showing papers on "Algorithmic trading published in 1994"

A Model of Competitive Stock Trading Volume

Abstract: A model of competitive stock trading is developed in which investors are heterogeneous in their information and private investment opportunities and rationally trade for both informational and noninformational motives. I examine the link between the nature of heterogeneity among investors and the behavior of trading volume and its relation to price dynamics. It is found that volume is positively correlated with absolute changes in prices and dividends. I show that informational trading and noninformational trading lead to different dynamic relations between trading volume and stock returns.

Trading on the Edge: Neural, Genetic, and Fuzzy Systems for Chaotic Financial Markets

Abstract: From the Publisher: Only a decade ago, spreadsheets were first invented for financial applications. At the time they were considered sophisticated modeling tools. Today machine intelligence is a core concept in describing advanced technologies that can develop more sophisticated models. Neural networks, genetic algorithms, and fuzzy systems provide new opportunities for automated trading, risk, and portfolio management. Machine learning techniques are quietly being used by investment managers for stock selection, bond pricing, foreign exchange trading, and market and bankruptcy predictions, as well as many other applications. They are the next step in the evolution of investment technology. Now, Trading on the Edge lets you in on this evolution. Assembled and edited by Guido J. Deboeck, a pioneer in the introduction of new technologies and financial applications of neural nets at the World Bank, this book is the product of more than a dozen authors around the globe who, over the past several years, have used these advanced technologies for investment management. The contributions from these experts demystify the application of these techniques and explore their impact on modern finance theory and practice. Most importantly, they show you how to apply those powerful techniques to automate trading, reduce risk, and improve portfolio management. Clearly, concisely, and in terms that traders and investment managers can relate to, this book shows how neural networks can learn complex patterns from vast quantities of data and generalize with amazing speed from learned experiences; how genetic algorithms can evolve solutions to problems in the way nature does; how fuzzy systems provide concrete solutions to problems based on vague parameters; and how nonlinear dynamics, fractal analysis, and chaos theory define order in what once were considered random changes in financial markets. The real-life case studies provided by these experts delineate proven strategies for applying advanced tech

Insider and Liquidity Trading in Stock and Options Markets

Abstract: We analyze the introduction of a nonredundant option, which completes the markets, and the effects of this on information revelation and risk sharing. The option alters the interaction between liquidity and insider trading. We find that the option mitigates the market breakdown problem created by the combination of market incompleteness and asymmetric information. The introduction of the option has ambiguous consequences on the informational efficiency of the market. One the one hand, by avoiding market breakdown, it enables trades to occur and convey information. On the other hand, the introduction of the option enlarges the set of trading strategies the insider can follow. This can make it more difficult for the market makers to interpret the information content of trades and consequently can reduce the informational efficiency of the market. The introduction of the option also has an ambiguous effect on the profitability of insider trades, which can either increase or decrease depending on parameter values. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Electronic Trading, Market Structure and Liquidity

Abstract: (1994). Electronic Trading, Market Structure and Liquidity. Financial Analysts Journal: Vol. 50, No. 1, pp. 39-50.

Trading and Liquidity on the Tokyo Stock Exchange: A Bird's Eye View

Abstract: The trading mechanism for equities on the Tokyo Stock Exchange (TSE) stands in sharp contrast to the primary mechanisms used to trade stocks in the United States. In the United States, exchange-designated specialists have affirmative obligations to provide continuous liquidity to the market. Specialists offer simultaneous and tight quotes to both buy and sell and supply sufficient liquidity to limit the magnitude of price changes between consecutive transactions. In contradistinction, the TSE has no exchange-designated liquidity suppliers. Instead, liquidity is provided through a public limit order book, and liquidity is organized through restrictions on maximum price changes between trades that serve to slow down trading. In this article, we examine the efficacy of the TSE's trading mechanisms at providing liquidity. Our analysis is based on a complete record of transactions and best-bid and best-offer quotes for most stocks in the First Section of the TSE over a period of 26 months. We study the size of the bid-ask spread and its cross-sectional and intertemporal stability; intertemporal patterns in returns, volatility, volume, trade size, and the frequency of trades; and market depth based on the response of quotes to trades and the frequency of trading halts and warning quotes. THE TRADING MECHANISM FOR equities on the Tokyo Stock Exchange (TSE) stands in sharp contrast to the primary mechanisms used to trade stocks in the United States. In the United States, exchange-designated specialists have affirmative obligations to provide continuous liquidity in the market and to maintain a (private) limit order book with the public's limit orders. On the TSE, exchange-designated intermediaries (saitori) log limit orders and match them to incoming market orders but provide no market-making services. In the United States, specialists offer simultaneous and tight quotes to both buy and sell. On the TSE, public limit orders constitute the available bids and offers. In the United States, specialists supply sufficient liquidity to limit the magnitude of price changes between consecutive transactions.1 On the TSE, the market mechanism places limits on the magnitude of consecutive price

Insider Trading Following Material News Events: Evidence from Earnings

Abstract: 0 Prior studies indicate that insider buying (selling) activity precedes positive (negative) abnormal returns that persist over relatively long horizons.1 Presumably, investors may benefit from knowledge of previous insider trades, and consistent with this, the financial press and investment advisors frequently provide information on insider trading activity.2 Recent efforts to reduce the incidence of insider trading based on non-public information have originated both from regulatory authorities and companies. Congress has passed several new laws regulating insider trading in the past decade, and the SEC has increased its enforcement of insider trading restrictions (see Arshadi and Eyssell [2, pp. 31-2]). Several companies have also adopted policies that restrict insider trading to time periods following news events such as quarterly earnings announcements. For instance, Compaq has a policy that limits insider transactions to the period following quarterly earnings reports (see "Heavy Insider Sales are Made at Compaq," The Wall Street Journal, June 9, 1993).3 The intended effect of such policies is presumably to "level the playing field" between insiders and external investors and ensure that the firm and its officers comply with the law.

Price Formation on Stock Exchanges: The Evolution of Trading within the Day

Abstract: Prior analyses of prices of the NYSE and other exchanges find that transitory price volatility is greater at the open of trading than at the close. We extend this line of research by using 40 years of hourly Dow Jones 65 Composite price index data to estimate transitory volatility throughout the trading day. Our results indicate that transitory volatility steadily declines during the trading day. We find a similar intraday decline in transitory volatility for a 2 1/2-year sample of the individual firms in the Dow Jones 30 Industrials Index. The results are consistent with the hypothesis that trading aids price formation and do not support the argument that particular trading mechanisms are the source of greater volatility at the open of trading. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Program Trading and Intraday Volatility

Abstract: Program trading and intraday changes in the S&P 500 Index are correlated. Future prices and, to a lesser extent, cash prices lead program trades. Index arbitrage trades are followed by an immediate change in the cash index, which ultimately reverses slightly. No reversal follows nonarbitrage trades. The cumulative index changes associated with buy-and-sell trades and with arbitrage and nonarbitrage trades all are similar. Price decompositions suggest that the results are not due to microstructure effects. Program trades in this 1989-1990 sample do not seem to have created major short-term liquidity problems. The results are stable within the sample. Many practitioners, regulators, and public commentators have expressed concerns about potential destabilizing effects of program trading. They argue that program trades–especially index arbitrage programs–increase intraday volatility and decrease

Insider Trading and the Managerial Choice among Risky Projects

Abstract: The concern of this paper is with the effects of insider trading on ex ante managerial behavior. Specifically, the paper focuses on how insider trading affects insiders' choice among investment projects. Other things equal, insider trading leads insiders to choose riskier investment projects, because increased volatility of results enables insiders to make greater trading profits if they learn these results in advance of the market. Thiseffect might be beneficial, however, because insiders' risk aversion pulls them toward aconservative investment policy. Insiders' choices of projects are identified and compared with insider trading and those without such trading. Using these results, the conditions under which insider trading increases or decreases corporate value by affecting the choice of projects with uncertain returns are identified.

Liquidity Changes Associated with Open Market Repurchases

Abstract: Before the tax-law changes of 1986, common stock repurchases received favorable tax treatment relative to cash dividends, yet more than 80% of the New York Stock Exchange-listed firms did not use repurchases for distributing value to their stockholders. Prior research suggests a possible resolution of the puzzle by examining the effect of open market repurchases on the liquidity of the firms' stocks. The liquidity of the stock as measured by bid-ask spread may be affected by stock repurchases in any one or all of the following ways. First, when management undertakes to reacquire the firm's shares in the open market they are, in effect, competing with the market makers of the stock. This open market repurchase activity, in the absence of information asymmetry, should result in greater liquidity or lower bid-ask spread. Second, a direct consequence of open market repurchase announcements may be increased trading in the secondary market. Increased trading volume makes it easier for the market maker to reverse his position in the stock. Therefore, the inventory holding cost component of bid-ask spread should decline upon announcements of open market repurchases. A decline in the bid-ask spread would be consistent with this explanation. Third, prior research suggests that open market repurchase announcements are associated with increased trading by informed traders in the secondary market for the firm's stock. Informed traders trade with market makers only at favorable prices. Hence, the adverse selection component of the bid-ask spread should increase in the post-announcement period. This information-asymmetry- based explanation predicts increased bid-ask spreads following announcements of open market repurchases. However, it should be noted that an asymmetric-information-based explanation does not necessarily imply that other market participants face the informed traders in all trades at all times. Specifically, the likelihood of trading with an informed trader is greater when stock prices are lower rather than higher. Also, repurchases only involve buying and not selling by informed traders. Hence, the risk of trading against the informed trader is much less.

Homo Economicus and Homo Politicus: Non-Economic Rationality in the Early 18th Century London Stock Market

Abstract: The case of the early 18th-century London stock market is used to evaluate economic and sociological theones of market trading. Data from 1712 on shares in two companies (the Bank of England and the East India Company), and on trading among three different groups (political parties, ethnic-religious groups, and guilds) are used to show how economic theories of rational trading do not account for market behavior, even though the 1712 London stock market was a highly centralized, organized and active capital market. Trading was embedded in domestic and mternational politics as party groups used the market to control joint-stock companies, and as ethnic-religious groups used the market to provide financial support for Britain's war with France In addition to economic goals, political goals were pursued in the market.

The linear and non-linear dependence of stock returns and trading volume in the Finnish stock market

Abstract: This paper investigates the dynamic linkages between stock returns and trading volume in a small stock market, i.e. the Helsinki Stock Exchange in Finland during the period 1977–88. Both linear and...

Non-Linear Predictive Models for Intra-Day Foreign Exchange Trading

Abstract: Artificial neural networks were used to search for non-linear relations in high- frequency foreign exchange time series. Three years 1985-7 tick-by-tick bid prices for the Swiss franc to the US dollar exchange rate were used in this study as training data to specify predictive models for intra-day trading, which was then tested on the same exchange rate time series in the following year 1988. A simple trading rule was adopted to evaluate the models, which showed statistically significant trading profit under moderate transaction costs. In contrast, a standard linear model did not produce profit with the same training and test data and under the same trading rule and transaction cost assumption. This provides evidence for the non-linear nature of the foreign exchange time series under study.

Optimal strategy in a trading problem with stochastic prices

Abstract: A stochastic, dynamic version of a one-commodity stock-exchange problem is considered. The market prices are described by a Markov chain. At the beginning of each period the decision maker knows the level of his inventory of a commodity and the present market price. Then he decides to buy or sell some amount of the commodity. The resulting amount is treated as the next period inventory. The capacity of the store and the amount of the purchase are limited. A linear holding cost is introduced. An optimal purchase-sell policy which minimizes expected cost is given.

Pre-announcement share price run-ups and abnormal trading volume in takeover target's shares: A test of the market speculation hypothesis☆

Abstract: This paper examines the effect of media speculation (a proxy for market speculation) on pre-announcement takeover target share price run-ups and abnormal trading volume. Using 60 Australian takeover targets over the period from the end of 1988 to mid 1992, it was found that media speculation has a substantial effect on pre-announcement share price activity. Media speculation however, was found not to have a significant effect on pre-announcement abnormal trading volume. The results appear to be more consistent with a market speculation argument than insider trading.

The Existence and Impact of Destabilizing Positive Feedback Traders: Evidence from the S&P 500 Index Futures Market

Abstract: Positive feedback investment is a speculative trading strategy in which individuals buy after price increases and sell after price declines. Theoretical models of this trading strategy have shown that prices can be destabilized. I examine individual accounts in the S&P 500 Index futures contract to detect positive feedback trading. A significant minority of active accounts perform positive feedback strategies more frequently than can be explained by chance. After periods of concentrated positive feedback trading, however, prices do not reverse as theory predicts. Test results of the relation between positive feedback volume and volatility are mixed: positive feedback volume and volatility are positively associated using two different techniques, but not a third technique.

Real-time object-oriented database support for program stock trading

Abstract: Many computer systems that automatically control financial applications are required to handle large amounts of data with timing constraints imposed on the data and on the transactions that access the data. Traditional database technology, however, is not designed to manage perishable (timeconstrained) data of financial applications, such as “current†stock prices and trading volumes in index arbitrage transactions. Furthermore, traditional database systems are not capable of scheduling the time-constrained transactions in financial applications, such as transactions that must be performed within time bounds of guaranteed price quotations. This paper presents a schema model of real-time objectoriented database that addresses these weaknesses and shows how this model can support a form of intelligent program stock trading called index arbitrage. This paper also illustrates the use of a protocol called timed atomic commitment, which is an extension of traditional distributed database atomic commitment protocol, to perform index arbitrage transactions using our real-time object-oriented database model.

Market maker competition on futures exchanges

Abstract: This study examines competition among the market makers in six futures pits. We first present a heterogeneous market maker model, allowing traders to dger according to their risk tolerance and/or capitalization. Those who are more risk tolerant or more highly capitalized capture greater volume by quoting tighter bid-ask spreads. We then look at the concentration of personal trading in actual futures pits, andfind it to be moderately concentrated: On a given day, an average of 30% to 60% of personal trading is conducted by the four largest traders in the pit. Concentration falls as volume rises, which is consistent with a prediction of the model that as volume rises, more risk-averse or lower-capitalized traders are able to participate in trading. Finally, we examine the relationship between personal trading volume and bid-ask spreads. Overall, the studyfinds only mild wi

Program Trading and Stock Index Arbitrage

Abstract: Stock index futures and program trading are among the most important financial market innovations of the 1980s. This chapter surveys the literature and provides an overview of the somewhat controversial area of index arbitrage. We begin with a description of how index futures work, how they should be priced in equilibrium according to the â¬Scost of carryâ¬? model, and how index arbitrage works to enforce the theoretical pricing relationship. In theory, index arbitrage is riskless, but we describe how it is affected in practice by transactions costs, execution risk, capital and short sales constraints, and the possibility of unwinding profitable trades before futures expiration. We end with a discussion of the impact of index futures and arbitrage on the volatility of the underlying stock market.

Dynamic price formation in a futures market via double auctions

Abstract: We report an exploratory study of the process of price formation in a speculative market in the absence of liquidity traders. Traders exchange a futures contract because they interpret information differently. We formulate trading as a sequence of anonymous double auctions and introduce a notion of bounded rationality in which traders use approximate models of market response in forming their bids. We prove existence of a perfect equilibrium in the sequential anonymous auctions game, and show that the equilibrium has a “no-regret” property. After learning the market price, a trader regrets neither the bid that he made nor the position that he holds. We show that trading volume is related to changes in the distribution of information in the economy. We also show that volume and expected change in price are related to two different attributes of the pattern of private information flow. Fundamentally, no particular relationship between the time series of these variables is always valid for all futures contracts. This point is emphasized by an example.

A hybrid approach for automated trading systems

Abstract: Automated trading systems have been proved to be very helpful to traders and investors However, most of the existing systems implemented with any statistical or neural network approaches are incapable to give accurate advice because they cannot capture the off-market information for which most of it is non-numeric In this paper, an automated trading system which integrates the techniques from technical analysis, pattern recognition, and knowledge-based system is presented The numeric data from the stock is processed by both the statistical method and feature extraction The intermediate results are then used by the rule-based system which captures the off-market information in form of facts and rules After that, the advice can be generated through the inference with the data stored in the database For resolving the inconsistencies among the intermediate results from different components of the system, concepts from the fuzzy set theories are employed Further, some data from the past Hang Seng Index (HSI) is used for illustration >

The Impact of Futures Trading on the Spot Market for Treasury Bonds

Abstract: Critics of futures markets contend that futures trading destabilizes spot prices and raises price levels of the underlying treasury bonds, while the proponents claim that futures trading improves the information content and stability of spot prices. To investigate these conflicting viewpoints, this paper examines the price behavior of treasury bonds at three critical time points: a) as they enter, retain, and exit the cheapest-to-deliver status; b) as they approach the futures delivery date; and, c) as they cease to be deliverable. An empirical analysis based on a rich data set of daily bond prices over thirty-four delivery quarters reveals little support for the critics’ view of futures trading.

Noise Trading, Transaction Costs, and the Relationship of Stock Returns and Trading Volume

Abstract: The relationship of stock returns and trading volume is the focus of much recent interest. I examine an economic model of a rational trader who operates in a market with transactions costs and noise trading. The level of trading affects the rational trader`s marginal cost of transacting; as a result, trading volume is a source of risk. This engenders an equilibrium relationship between returns and volume. The model also provides a simple way to scrutinize this relationship empirically. Empirical evidence supports the implications of the model.

Equilibrium Fee Schedules in a Monopolist Call Market

Abstract: Liquidity plays a crucial role in financial exchange markets. Markets typically create liquidity through spatial consolidation with specialist/market makers matching orders arriving at different times. However, continuous trading systems have an inherent weakness in the potential for insufficient liquidity. This risk was highlighted during the 1987 market crash. Subsequent proposals suggested time consolidation in the form of call markets integrated into the continuous trading environment. This paper explores the optimal fee schedule for a monopolist call market auctioneer competing with a continuous auction market. Liquidity is an externality in that traders are not fully compensated for the liquidity they bring to the market. Thus, in the absence of differential transaction costs, traders have an incentive to delay order entry resulting in significant uncertainty in the number of traders participating at the call. A well-designed call market mechanism has to mitigate this uncertainty. The trading mechanism examined utilizes two elements: commitments to trade and discounts in fees for early commitment; thus, optimal transaction fees are time-dependent. Traders who commit early are rewarded for the enhanced liquidity that their commitment provides to the market. As participants commit earlier they pay strictly lower fees and are strictly better off by participating in the call market rather than in the continuous market. A comparison to the social welfare maximizing fee schedule shows that the monopolist does not internalize the externality completely, with the social welfare maximizing schedule offering lower fees to all traders.

On the computational complexity of the maximum trade problem

Abstract: Consider a computer assisted trading system in which the needs and the products of the traders are compared by a computer system and the trading proceeds without attaching a dollar price to each commodity. In such a system the computer serves as an “intelligent” communication link between traders, enhancing the ability of producers and consumers to exchange goods. In this paper, we examine one computational aspect of such computerized trading schemes: Given a list of trading proposals (each proposal specifying the quantities of the commodities to be traded), how should one arrange the trades so that the maximum number of trades can be made in the market? We show that this maximum trade problem is computationally hard; it is NP-complete (Nondeterministic Polynomial Time Complete). We then describe some related open questions and potential solutions.

Accounting for emissions trading programs

Abstract: Emissions trading programs offer opportunities for tremendous cost savings and operating flexibility, but they raise a host of financial and tax accounting problems. This article describes how these new programs work and the issues they raise.