Showing papers on "Algorithmic trading published in 2003"
TL;DR: In this paper, the authors consider the problem of liquidating a large single-asset portfolio to minimize a combination of volatility risk and market impact costs, with an arbitrary positive exponent.
Abstract: Optimal trading strategies are determined for liquidation of a large single-asset portfolio to minimize a combination of volatility risk and market impact costs. The market impact cost per share is taken to be a power law function of the trading rate, with an arbitrary positive exponent. This includes, for example, the square root law that has been proposed based on market microstructure theory. In analogy to the linear model, a ‘characteristic time’ for optimal trading is defined, which now depends on the initial portfolio size and decreases as execution proceeds. A model is also considered in which uncertainty of the realized price is increased by demanding rapid execution; it is shown that optimal trajectories are described by a ‘critical portfolio size’ above which this effect is dominant and below which it may be neglected.
522 citations
TL;DR: In this article, the authors examined the effects of trading after hours on the amount and timing of price discovery over the 24-hour day and found that relatively low after-hours trading volume can generate significant price discovery, although prices are noisier after hours, implying that the price discovery is less efficient.
Abstract: We examine the effects of trading after hours on the amount and timing of price discovery over the 24-hour day. A high volume of liquidity trade facilitates price discovery. Thus prices are more efficient and more information is revealed per hour during the trading day than after hours. However, the low trading volume after hours generates significant, albeit inefficient, price discovery. Individual trades contain more information after hours than during the day. Because information asymmetry declines over the day, price changes are larger, reflect more private information, and are less noisy before the open than after the close. Technology has dramatically changed the way stock markets operate by allowing investors to trade directly with each other, both during and outside of exchange trading hours. Although it is now relatively easy to trade after hours, in reality most investors do not. Only 4% of Nasdaq trading volume occurs after hours. This article examines how investors’ decisions to trade after hours or during the trading day affect the process through which new information is incorporated into security prices. We find that relatively low after-hours trading volume can generate significant price discovery, although prices are noisier after hours, implying that the price discovery is less efficient. Variation in the amount of informed and uninformed trading is relatively small, both within the trading day [Admati and Pfleiderer (1988), Wood, McInish, and Ord (1985), Madhavan, Richardson, and Roomas (1997)] and across trading days [Foster and Viswanathan (1993)]. In contrast, there are large shifts in the trading process at the open and at the close. These large shifts make it possible to examine price discovery under conditions very different from those studied previously and allow us to address the following four questions regarding the relationship between trading and price discovery. First, how does the trading process affect the
382 citations
TL;DR: In this article, the authors explore the competition between two trading venues, Electronic Communication Networks (ECNs) and Nasdaq market makers, and show that trades are more likely to occur on ECNs when information asymmetry is greater and when trading volume and stock-return volatility are high.
Abstract: This paper explores the competition between two trading venues, Electronic Communication Networks (ECNs) and Nasdaq market makers. ECNs oier the advantages of anonymity and speed of execution, which attract informed traders. Thus, trades are more likely to occur on ECNs when information asymmetry is greater and when trading volume and stock-return volatility are high. ECN trades have greater permanent price impacts and more private information is revealed through ECN trades than though market-maker trades. However, ECN trades have higher ex ante trading costs because market makers can preference or internalize the less informed trades and oier them better executions. TECHNOLOGICAL INNOVATIONS THAT ENABLE HIGH-SPEED, low-cost electronic trading systems are dramatically changing the structure of ¢nancial markets. Exchanges and markets around the world are merging or forming alliances to improve liquidity and reduce costs in the face of increased competition from each other and from these computerized trading systems. Trading volume on Electronic Communications Networks (ECNs) has grown rapidly over the past several years. ECNs are now involved in more than a third of Nasdaq trading volume and are attempting to increase their market share in NYSE-listed
352 citations
TL;DR: In this article, the authors employ a new USD/DEM data set covering the activities of multiple dealers over one trading week to quantify the permanent effects of trades on quotes and show that asymmetric information accounts for around 60% of average bid-ask spreads.
308 citations
TL;DR: This article found that foreign investors and external conditions have a larger impact on emerging markets than implied by previous work, and that the price impacts associated with foreign investors' trading are much larger than earlier estimates, consistent with permanent price pressures from demand shocks.
Abstract: Daily data for foreign investors' trading in six Asian emerging equity markets provide two new findings. First, foreigners' flows into several markets show positive-feedback trading with respect to global, as well as domestic, equity returns. The nature of this trading suggests it is due to behavioural factors or foreigners extracting information from recent returns, rather than portfoliorebalancing effects. Second, the price impacts associated with foreigners' trading are much larger than earlier estimates, and would be consistent with permanent price pressures from demand shocks. The results suggest that foreign investors and external conditions have a larger impact on emerging markets than implied by previous work.
239 citations
Posted Content•
TL;DR: The first evidence of localized trading is that the time zone of a company's headquarters affects intraday trading patterns in its stock as discussed by the authors, which shows that stocks of west coast firms have lower volume early in the trading day than east coast companies and do not exhibit the steep decline in volume documented for the east coast lunch hour.
Abstract: We document by several methods that trading in Nasdaq stocks is localized. The first evidence of localized trading is that the time zone of a company's headquarters affects intraday trading patterns in its stock. Stocks of west coast firms have lower volume early in the trading day than east coast companies and do not exhibit the steep decline in volume documented for the east coast lunch hour. Second, firms in blizzard-struck cities see a dramatic trading volume drop compared to firms in other cities. On average, about 1/3 of a normal day's trading volume is lost when a blizzard strikes. Third, trading volume drops for stocks in general during Yom Kippur, but the effect is particularly strong for cities with large Jewish populations. The finding that trading in Nasdaq stocks is geographically concentrated allows us to construct powerful alternative tests of other researchers' finding that stock returns are lower on cloudy days. We construct portfolios of Nasdaq stocks based in 25 cities. We are unable to find any evidence that cloud cover in the city of a company's headquarters affects its stock returns.
211 citations
TL;DR: This article analyzed the use of alternative trading systems in a large sample of institutional orders and the trades that constitute these orders and found that realized execution costs are generally lower on alternative trading system.
208 citations
TL;DR: In this paper, the authors re-examine the profitability of relative strength, or momentum, trading strategies (buying past strong performers and selling past weak performers) and find that standard relative strength strategies require frequent trading in disproportionately high-cost securities so that trading costs prevent profitable strategy execution.
Abstract: In markets with trading friction, the incorporation of information into market prices can be substantially delayed through a weakening of the arbitrage process. We re-examine the profitability of relative-strength, or momentum, trading strategies (buying past strong performers and selling past weak performers). We find that standard relative-strength strategies require frequent trading in disproportionately high-cost securities so that trading costs prevent profitable strategy execution. In the cross section, we find that those stocks that generate large momentum returns are precisely those stocks with high trading costs. We conclude that the magnitude of the abnormal returns associated with these trading strategies creates an illusion of profit opportunity when, in fact, none exists.
185 citations
Proceedings Article•
09 Dec 2003TL;DR: The empirical results on historical markets provide strong evidence that this type of technical trading can "beat the market" and moreover, can beat the best stock in the market.
Abstract: A novel algorithm for actively trading stocks is presented. While traditional universal algorithms (and technical trading heuristics) attempt to predict winners or trends, our approach relies on predictable statistical relations between all pairs of stocks in the market. Our empirical results on historical markets provide strong evidence that this type of technical trading can "beat the market" and moreover, can beat the best stock in the market. In doing so we utilize a new idea for smoothing critical parameters in the context of expert learning.
167 citations
TL;DR: In this paper, the welfare economics of informed stock market trading is studied. And the authors analyze the effect of more informative prices on investment, given that this dependence will itself be reflected in equilibrium prices.
Abstract: This article studies the welfare economics of informed stock market trading. We analyze the effect of more informative prices on investment, given that this dependence will itself be reflected in equilibrium prices. While a higher incidence of informed speculation always increases firm value through a more informative trading process, the effect on agents’ welfare depends on how revelation of information changes risk‐sharing opportunities in the market. Greater revelation of information that agents wish to insure against reduces their hedging opportunities. On the other hand, early revelation of information that is uncorrelated with hedging needs allows agents to construct better hedges.
129 citations
TL;DR: In this paper, the authors investigated the relationship between daily returns and trading volume for 20 Polish stocks and found that volatility persistence tends to disappear when trading volume is included in the conditional variance equation, which is in agreement with the findings of studies on developed stock markets.
TL;DR: In this article, the authors investigated the trading mechanism and other structural features of 51 stock exchanges and analyzed the impact of these institutional characteristics on liquidity measures such as closing bid-ask spreads, volatility and trading turnover.
Abstract: The paper investigates the trading mechanism and other structural features of 51 stock exchanges and analyzes the impact of these institutional characteristics on liquidity measures such as closing bid-ask spreads, volatility and trading turnover. Exchange-design features such as narrower tick sizes, designated market makers, consolidated limit order books, hybrid trading mechanisms, automated trade execution, consolidated order-flow, and better shareholder rights are associated with lower spreads. These features also influence volatility and trading turnover, which in turn further affect spreads. Overall liquidity is highest on hybrid trading mechanisms compared to pure limit order books or quote-based dealer system because the former have two sources of liquidity. These results have important implications for investors' trading strategy, firms' listing strategy, and exchanges' organizational strategy.
TL;DR: In this paper, a controlled experiment examining changes in trader behavior, displayed liquidity supply, and execution quality around the reduction in the minimum price variation to $0.01 was conducted, where traders did not substantially reduce their use of traditional limit orders in favor of market orders or non-displayed orders.
Book•
09 Jul 2003
TL;DR: The Holy Grail of market impact as discussed by the authors is the number of transactions in a post-trade analysis of a pre-trade trade. And the post-transaction analysis of the pre-and post-trading trade.
Abstract: "1. Transaction Cost 2. Unbundled Trading Costs 3. Pre-Trade Analysis 4. Price Appreciation 5. Market Impact 6. Timing Risk 7. Opportunity Cost 8. The Holy Grail of Market Impact 9. Optimal Trading Strategies 10. Principal Bid Transactions 11. VWAP Trading Strategies 12. Advanced Trading Techniques 13. Post Trade Analysis"
TL;DR: The Penn-Lehman automated trading project's centerpiece is the Penn exchange simulator (PXS), a software simulator for automated stock trading that merges automated client orders for shares with real-world, real-time order data.
Abstract: The Penn-Lehman automated trading project is a broad investigation of algorithms and strategies for automated trading in financial markets. The PLAT project's centerpiece is the Penn exchange simulator (PXS), a software simulator for automated stock trading that merges automated client orders for shares with real-world, real-time order data. PXS automatically computes client profits and losses, volumes traded, simulator and external prices, and other quantities of interest. To test the effectiveness of PXS and of various trading strategies, we've held three formal competitions between automated clients.
TL;DR: In this article, the authors investigated the possible relation between weather and market index returns in the context of the Spanish market and found that, independently of the trading system, there is no influence of weather on stock prices.
Abstract: Psychological studies support the existence of an influence of weather on mood. Saunders (1993) and Hirshleifer and Shumway (2001) argue that the weather could affect the behaviour of market traders and, therefore, it should be reflected in the stock returns. This paper investigates the possible relation between weather and market index returns in the context of the Spanish market. In 1989, this market changed its open outcry trading system into a computerised and decentralised trading system. Therefore, it is possible to check the influence of weather variables (sunshine hours and humidity levels) on index returns in an open outcry trading system, and to compare it with a screen traded environment. The empirical evidence indicates that, independently of the trading system, there is no influence of weather on stock prices. Thus, these findings do not contest the notion of efficient markets.
01 Apr 2003
TL;DR: Experimental results and theoretical analyses showed that agents guided by market-driven strategies achieve trading outcomes that correspond to intuitions in real-life trading.
Abstract: Market-driven agents are negotiation agents that react to changing market situations by making adjustable rates of concession. This paper presents 1) the foundations for designing market-driven strategies of agents, 2) a testbed of market-driven agents, 3) experimental results in simulating the market-driven approach, and 4) theoretical analyses of agents' performance in extremely large markets. In determining the amount of concession for each trading cycle, market-driven agents in this research are guided by four mathematical functions of eagerness, remaining trading time, trading opportunity , and competition. At different stages of trading, agents may adopt different trading strategies, and make different rates of concession. Four classes of strategies with respect to remaining trading time are discussed. Trading opportunity is determined by considering: 1) number of trading partners, 2) spreads-differences in utilities between an agent and its trading partners, and 3) probability of completing a deal. While eagerness represents an agent's desire to trade, trading competition is determined by the probability that it is not considered as the most preferred trader by its trading partners. Experimental results and theoretical analyses showed that agents guided by market-driven strategies 1) react to changing market situations by making prudent and appropriate rates of concession, and 2) achieve trading outcomes that correspond to intuitions in real-life trading.
TL;DR: In this article, the authors investigated the presence of abnormal returns through the use of trading strategies that exploit the predictability of short run stock price movements and identified profitable momentum trading strategies as investment tools over the period 1955-96.
TL;DR: In this paper, a simple pairs trading strategy with automatic extreme risk control using the entire universe of securities in the highly liquid secondary market for U.S. government debt is presented.
Abstract: This paper examines the implementation of a simple pairs trading strategy with automatic extreme risk control using the entire universe of securities in the highly liquid secondary market for U.S. government debt. It documents, from a practical viewpoint, the contrasts in the generic features of pairs trading with such securities compared with equities. The rewards emanating from the proposed strategy, after constructing an appropriate risk benchmark, are appraised using various traditional and relatively newer metrics. Using data from the repo and money market, estimates are also made of the distribution of absolute returns after accounting for financing and transaction costs.
TL;DR: The 2001 Trading Agent Competition as discussed by the authors was the second in a series of events aiming to shed light on research issues in automating trading strategies, focusing on a challenging market scenario in the domain of travel shopping, presenting agents with difficult issues in bidding strategy, market prediction and resource allocation.
Abstract: The 2001 Trading Agent Competition was the second in a series of events aiming to shed light on research issues in automating trading strategies. Based on a challenging market scenario in the domain of travel shopping, the competition presents agents with difficult issues in bidding strategy, market prediction and resource allocation. Entrants in 2001 demonstrated substantial progress over the prior year, with the overall level of competence exhibited suggesting that trading in online markets is a viable domain for highly autonomous agents.
TL;DR: In this paper, the authors test whether momentum-based strategies remain profitable after considering market frictions, in particular price concessions induced by trading, and find that, after taking into account the price impact induced by trades, as much as 5 billion dollars (relative to December 1999 market capitalization) may be invested in some momentum based strategies before the apparent profit opportunities vanish.
Abstract: This paper tests whether momentum-based strategies remain profitable after considering market frictions, in particular price concessions induced by trading. Alternative measures of price impact are estimated and applied to alternative momentum-based trading rules. The performance of traditional momentum strategies, in addition to strategies designed to reduce the cost of trades, is evaluated. We find that, after taking into account the price impact induced by trades, as much as 5 billion dollars (relative to December 1999 market capitalization) may be invested in some momentum-based strategies before the apparent profit opportunities vanish. Other, extensively studied, momentum strategies are not implementable on a large scale. The persistence of momentum returns exhibited in the data remains an important challenge to the asset-pricing literature.
TL;DR: In this paper, the authors use a detailed data set from a large investor in the US equity markets to find evidence that competition from crossing networks is concentrated in the most liquid stocks in a sample of the largest companies in the United States.
Abstract: The trading volume channeled through off-market crossing networks is growing. Passive matching of orders outside the primary market lowers several components of execution costs compared to regular trading. On the other hand, the risk of non-execution imposes opportunity costs, and the inherent “free riding” on the price discovery process raises concerns that this eventually will lead to lower liquidity in the primary market. Using a detailed data set from a large investor in the US equity markets, we find evidence that competition from crossing networks is concentrated in the most liquid stocks in a sample of the largest companies in the US. Simulations of alternative trading strategies indicate that the investor’s strategy of initially trying to cross all stocks was cost effective: in spite of their high liquidity, the crossed stocks would have been unlikely to achieve at lower execution costs in the open market.
TL;DR: The authors studied stock returns and trading volume surrounding the crash of the space shuttle Challenger and found that price discovery occurred without large trading profits and that much of the price discovery happened during a trading halt of the firm responsible for the faulty component.
TL;DR: In this article, the authors study the long-run wealth distribution of agents with different trading strategies in the framework of the Genoa Artificial Stock Market, an agent-based simulated market able to reproduce the main stylised facts observed in financial markets, such as fat-tailed distribution of returns and volatility clustering.
Abstract: In this paper, we study the long-run wealth distribution of agents with different trading strategies in the framework of the Genoa Artificial Stock Market. The Genoa market is an agent-based simulated market able to reproduce the main stylised facts observed in financial markets, i.e., fat-tailed distribution of returns and volatility clustering. Various populations of traders have been introduced in a 'thermal bath' made by random traders who make random buy and sell decisions constrained by the available limited resources and depending on past price volatility. We study both trend following and trend contrarian behaviour; fundamentalist traders (i.e., traders believing that stocks have a fundamental price depending on factors external to the market) are also investigated. Results show that the strategy alone does not allow forecasting which population will prevail. Trading strategies yield different results in different market conditions. Generally, in a closed market (a market with no money creation process), we find that trend followers lose relevance and money to other populations of traders and eventually disappear, whereas in an open market (a market with money inflows), trend followers can survive, but their strategy is less profitable than the strategy of other populations.
TL;DR: In this article, the authors distinguish two components of self-confidence in a financial market: private selfconfidence measures the selfconfidence of speculators, while public self confidence measures the confidence they attribute to their competitors, and study how independent changes in these components affect the trading strategies.
TL;DR: For the fourth edition of this competition, TAC-03, to be held in August 2003, the authors have created a novel supply-chain trading game with the aim of investigating automated agents in the context of dynamic supply- chain management.
Abstract: The Trading Agent Competition (TAC) has now become an annual fixture since its inception in 2000. The competition was conceived with the objective of studying automated trading strategies by focusing the research community on the development of competing solutions to a common trading scenario. The success of past TAC events has motivated broadening the scope of the competition beyond the context of the travel agent scenario used thus far. For the fourth edition of this competition, TAC-03, to be held in August 2003, the authors have created a novel supply-chain trading game with the aim of investigating automated agents in the context of dynamic supply-chain management.
Posted Content•
TL;DR: In this paper, the authors explain the functioning of electronic brokers and internet trading and discuss the economic consequences of the electronic brokers in the interbank market and the online trading for customers.
Abstract: The foreign exchange market can be divided in two segments: the interbank market and the customer market. Two recent advances in trading technology, electronic brokers in the interbank market and internet trading for customers, have significantly changed the structure of the foreign exchange market. In this paper we explain the functioning of electronic brokers and internet trading and discuss the economic consequences.
TL;DR: In this article, the effects of online trading on stock price and trading volume reactions to quarterly earnings announcements were investigated and it was shown that online trading has increased the proportion of naive investors in the market.
Abstract: This study provides evidence regarding the effects of online trading on stock price and trading volume reactions to quarterly earnings announcements. We test for differences in stock price and volume reactions to quarterly earnings announcements between a period with a significant amount of online trading (1996-99) and a period without online trading (1992-95). We conjecture that online trading has increased the proportion of naive investors in the market. We predict that this will result in (1) a decrease in the average precision of investor information prior to earnings announcements leading to higher earnings response coefficients (ERCs), (2) an increase in differential interpretation of earnings leading to higher trading volume reactions that are unrelated to price change, and (3) a decrease in differential prior precision leading to a decrease in the association between trading volume and absolute price change. We find evidence consistent with all three predictions. Our findings are relevant for assessing the validity of concerns about online trading expressed by regulators and the validity of theoretical models of trade with asymmetrically informed investors.
Patent•
09 Jun 2003
TL;DR: An electronic system for aggregated pricing of linked multi-leg (e.g., equity/option and option/option) asset packages with an additional link to an automated broker system for trading the linked asset packages are disclosed in this paper.
Abstract: An electronic system for aggregated pricing of linked multi-leg (e.g., equity/option and option/option) asset packages with an additional link to an automated broker system for trading the linked asset packages are disclosed. The invention provides methodology and apparatus to electronically produce aggregated price quotes for packages of instruments designed to represent traditional trading strategies involving cash and their derivatives (e.g., stock and equity options). The system develops packages according to specified strategies, and prices the packages based on the national best bid and offer (NBBO) or direct input from participating market makers and investors. The packages are designed for easy understanding by traditional investors and designed for trading through a single order. These packages are desirable over separately trading the asset and its derivative (e.g., equity and option) instruments because they transfer market volatility risk from the investor to the institution by requiring market makers to agree to the aggregated price of the package prior to executing any trades. Certain linked packages, such as most stocks and options, cannot be traded together on a single floor of an exchange due to restrictions by the Securities and Exchange Commission (SEC) regarding side-by-side trading and integrated market making of most stocks and options. This invention provides an electronic process for synthetic side-by-side trading across separate trading locations (e.g., equity and option exchanges and within the existing rules of the SEC). The electronic process follows traditional rules regarding the manual handling of combination orders involving multiple asset types. The process significantly improves efficiency over manual handling resulting in a system that is scalable to high trade volumes.
TL;DR: Evidence is found that momentum and value trading strategies constitute statistical arbitrage opportunities, despite controlling for transaction costs and the influence of small stocks, and their profitability does not appear to decline over time.
Abstract: This paper introduces the concept of statistical arbitrage, a long horizon trading opportunity that generates a riskless profit and is designed to exploit persistent anomalies. Statistical arbitrage circumvents the "joint hypothesis" dilemma of traditional market efficiency tests because its definition is independent of any equilibrium model and its existence is incompatible with market efficiency. We provide a methodology to test for statistical arbitrage and then empirically investigate whether momentum and value trading strategies constitute statistical arbitrage opportunities. Despite controlling for transaction costs and the influence of small stocks, we find evidence that these strategies generate statistical arbitrage. Furthermore, their profitability does not appear to decline over time.