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Showing papers on "Algorithmic trading published in 2005"


Journal ArticleDOI
TL;DR: In this paper, the authors present a theory of excess stock market volatility, in which market movements are due to trades by very large institutional investors in relatively illiquid markets, and derive the optimal trading behavior of thse investors, which allows them to provide a unified explanation for apparently disconnected empirical regularities in returns, trading volume and investor size.
Abstract: We present a theory of excess stock market volatility, in which market movements are due to trades by very large institutional investors in relatively illiquid markets. Such trades generate significant spikes in returns and volume, even in the absence of important news about fundamentals. We derive the optimal trading behavior of thse investors, which allows us to provide a unified explanation for apparently disconnected empirical regularities in returns, trading volume and investor size.

417 citations


Journal ArticleDOI
TL;DR: In this article, the authors investigate the nature of trading discipline and whether professional traders are able to avoid the costly irrational behaviors found in retail populations, and find no evidence of costs associated with this behavior.

359 citations


Journal ArticleDOI
TL;DR: In this article, the authors examined the effect of increased transparency on the Toronto Stock Exchange's limit order book on both the traditional floor and on its automated trading system and found that the increase in transparency reduces liquidity.

318 citations


Journal ArticleDOI
TL;DR: In this paper, the authors studied trading costs for 412 NYSE-listed ADRs from 44 countries and concluded that improvements in legal and political institutions will lower the cost of liquidity in stock markets.
Abstract: We conjecture that macro-level institutions will affect equity trading costs through their impact on information risk and investor participation. The key findings from our study of trading costs for 412 NYSE-listed ADRs from 44 countries are as follows. After controlling for firm-level determinants of trading costs and home country market share, effective spreads and price impact of trades are significantly lower for stocks from countries with better ratings for judicial efficiency, accounting standards, and political stability. Trading costs are significantly higher for stocks from French civil law countries than from common law countries. We confirm the robustness of our results in various analyses. Overall, we conclude that improvements in legal and political institutions will lower the cost of liquidity in stock markets.

190 citations


Journal ArticleDOI
TL;DR: In this paper, the authors analyzed the effect of information leakage on trading behavior and market efficiency in the stock market and found that information leakage makes the price process more informative in the short-run, it reduces its informativeness in the long-run.
Abstract: This article analyzes the effects of information leakage on trading behavior and market efficiency. A trader who receives a noisy signal about a forthcoming public announcement can exploit it twice. First, when he receives it, and second, after the public announcement since he knows best the extent to which his information is already reflected in the pre-announcement price. Given his information he expects the price to overshoot and intends to partially revert his trade. While information leakage makes the price process more informative in the short-run, it reduces its informativeness in the long-run. The analysis supports Securities and Exchange Commission’s Regulation Fair Disclosure. In a perfect world, all investors would receive information pertinent to the value of the stock immediately and simultaneously. In reality, however, some agents like corporate insiders and their favored analysts can receive signals about this information before it is disclosed to the general public. The focus of our analysis is to determine (i) the optimal trading strategy of an early-informed agent and (ii) the implications of this trading behavior for the informational efficiency of the stock market. This knowledge can facilitate the design and evaluation of trading regulations by the Securities and Exchange Commission (SEC). Our model generates several novel insights on insider trading by enriching the information structure typically employed in the prior literature. In our analysis, a trader receives an early imprecise signal about a forthcoming news announcement — possibly in the form of a rumor. The new element is that the stock price reflects unrelated long-run private information held by other traders as well as the early-informed trader’s short-run signal. Given this generalized information structure, we find that the early-informed agent’s trading strategy exhibits three features: (1) he trades based on his private information twice, once before the public

189 citations


Journal ArticleDOI
TL;DR: In this article, the authors contribute to the literature on institutional herding and feedback trading by analysing the investment behavior of pension funds on the Polish stock market Pension funds entered into the stock market due to the national pension system reform in 1999, providing a unique opportunity to receive deeper insight into the behavior of institutional investors in an emerging capital market.
Abstract: In this paper, we contribute to the literature on institutional herding and feedback trading by analysing the investment behavior of pension funds on the Polish stock market Pension funds entered into the stock market due to the national pension system reform in 1999, providing a unique opportunity to receive deeper insight into the behavior of institutional investors in an emerging capital market Our results show that Polish pension fund investors are to a greater extent involved in herd-like behavior and pursue feedback trading strategies more often than their counterparts in mature markets This finding is primarily attributed to a stringent investment regulation and high market concentration We do not detect, however, that trading by the pension funds exerts significant influence on the future stock prices

182 citations


Journal ArticleDOI
TL;DR: In this article, the authors test the hypothesis that the introduction of index futures has increased positive feedback trading in the spot markets of six industrialized nations and find no evidence that positive feedback traders migrated from the spot to the futures markets.

176 citations


Journal ArticleDOI
TL;DR: In this article, the authors analyzed a number of key factors that will influence the price of emission allowances in the EU emissions trading system in the 2005-2007 period, including: policy and regulatory issues; market fundamentals, including weather and production levels; together with technical indicators.

172 citations


Journal ArticleDOI
TL;DR: In this paper, the authors reexamine the profitability of technical analysis using White's reality check and Hansen's SPA test that correct the data snooping bias, and find that simple rules and complex trading strategies are able to improve on the profits of simple rules.
Abstract: In this article we reexamine the profitability of technical analysis using White's reality check and Hansen's SPA test that correct the data snooping bias. Compared to previous studies, we study a more complete "universe" of trading techniques, including not only simple rules but also complex trading strategies, and we test the profitability of these rules and strategies with four main indices. It is found that significantly profitable simple rules and complex trading strategies do exist in the data from relatively "young" markets (NASDAQ Composite and Russell 2000) but not in the data from relatively "mature" markets [Dow Jones Industrial Average (DJIA) and S&P 500]. Moreover, after taking transaction costs into account, we find that the best rules for NASDAQ Composite and Russell 2000 outperform the buy-and-hold strategy in most in- and out-of-sample periods. It is also found that complex trading strategies are able to improve on the profits of simple rules and may even generate significant profits from unprofitable simple rules. Copyright 2005, Oxford University Press.

170 citations


Journal ArticleDOI
TL;DR: In this article, the authors show that risk-averse traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility or liquidity increases.
Abstract: A liquidity trader wishes to trade a fixed number of shares within a certain time horizon and to minimize the mean and variance of the costs of trading. Explicit formulas for the optimal trading strategies show that risk-averse liquidity traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility or liquidity increases. In the presence of transaction fees, traders want to trade less often when either price volatility or liquidity goes up or when the speed of price reversion declines. In the multi-asset case, price effects across assets have a substantial impact on trading behavior.

166 citations


Journal ArticleDOI
TL;DR: In this article, the authors develop a simple framework to model the dynamics of supply/demand and its impact on execution cost, and show that the optimal execution strategy involves both discrete and continuous trades, not only continuous trades.
Abstract: The supply/demand of a security in the market is an intertemporal, not a static, object and its dynamics is crucial in determining market participants' trading behavior. Previous studies on the optimal trading strategy to execute a given order focuses mostly on the static properties of the supply/demand. In this paper, we show that the dynamics of the supply/demand is of critical importance to the optimal execution strategy, especially when trading times are endogenously chosen. Using a limit-order-book market, we develop a simple framework to model the dynamics of supply/demand and its impact on execution cost. We show that the optimal execution strategy involves both discrete and continuous trades, not only continuous trades as previous work suggested. The cost savings from the optimal strategy over the simple continuous strategy can be substantial. We also show that the predictions about the optimal trading behavior can have interesting implications on the observed behavior of intraday volume, volatility and prices.

Journal ArticleDOI
TL;DR: The authors examine trading volumes of firms changing from NASDAQ to the NYSE since 1997 and document that reported trading volume for NASDAQ stocks continues to be overstated, and the degree of overstatement is much larger for firms with high trading volume.
Abstract: Historically, trading volume reported for NASDAQ stocks has been overstated vis-a-vis New York Stock Exchange (NYSE) stocks, both because of the dealer's participation in trades as a market maker and because of interdealer trading. Beginning in 1997, the Securities and Exchange Commission changed order-handling rules and trade-reporting rules, which may have reduced or eliminated the overstatement of NASDAQ trading. We examine trading volumes of firms changing from NASDAQ to the NYSE since 1997 and document that reported trading volume for NASDAQ stocks continues to be overstated. Moreover, the degree of overstatement is much larger for firms with high trading volume.

Posted Content
TL;DR: The authors examined the lead-lag relationship between futures trading activity (volume and open interest) and cash price volatility for major agricultural commodities and found that an unexpected increase in futures trading volume unidirectionally causes an increase in Cash Price volatility for most commodities.
Abstract: This paper examines the lead-lag relationship between futures trading activity (volume and open interest) and cash price volatility for major agricultural commodities. Granger causality tests and generalized forecast error variance decompositions show that an unexpected increase in futures trading volume unidirectionally causes an increase in cash price volatility for most commodities. Likewise, there is a weak causal feedback between open interest and cash price volatility. These findings are generally consistent with the destabilizing effect of futures trading on agricultural commodity markets.

Journal ArticleDOI
TL;DR: In this article, the intraday price discovery process between regular index futures and E-mini index futures (electronic trading) in the S&P 500 and Nasdaq 100 index futures markets is examined, using intradays data from the introduction of the E-minis index futures to 2001.
Abstract: In this article the intraday price discovery process between regular index futures (floor trading) and E-mini index futures (electronic trading) in the S&P 500 and Nasdaq 100 index futures markets is examined, using intraday data from the introduction of the E-mini index futures to 2001. Using both information shares (Hasbrouck, J., 1995) and common long-memory factor weights (Gonzalo, J., & Granger, C. W. J., 1995) techniques, we find that both E-mini index futures and regular index futures contribute to the price discovery process. However, since September 1998, the contribution made by E-mini index futures has been greater than that provided by regular index futures. Based on regression analysis, we have also found direct empirical evidence to support the hypothesis that the joint effects of operational efficiency and relative liquidity determine the greater contribution made towards price discovery by electronic trading relative to open-outcry trading over time. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25: 679–715, 2005

Journal ArticleDOI
TL;DR: In this article, the comparative performance of an Adaptive Moving Average (AMA) on the Australian All Ordinaries, Dow Jones Industrial Average, and Standard and Poor's 500 stock market indices is examined.

Journal ArticleDOI
Fan Yu1
TL;DR: In this paper, the authors examined the risk and return of the so-called capital structure arbitrage, which exploits the mispricing between a company's debt and equity, and proposed a convergence-type trading strategy based on the deviation of CDS market spreads from their theoretical counterparts.
Abstract: This paper examines the risk and return of the so-called capital structure arbitrage, which exploits the mispricing between a company's debt and equity. Specifically, a structural model connects a company's equity price with its credit default swap (CDS) spread. Based on the deviation of CDS market spreads from their theoretical counterparts, a convergence-type trading strategy is proposed and analyzed using 135,759 daily CDS spreads on 261 obligors. At the level of individual trades, the risk of the strategy arises when the arbitrageur shorts CDS and the market spread subsequently skyrockets, forcing the arbitrageur into early liquidation and engendering large losses. An equally-weighted portfolio of all trades produces Sharpe ratios similar to those of other fixed-income arbitrage strategies and hedge fund industry benchmarks. However, the monthly excess returns on this portfolio are not significantly correlated with either equity or bond market factors.

Journal ArticleDOI
TL;DR: In this article, the forecasting power of two of the most popular trading rules using index data for a selection of 11 European stock markets over the January 1991 to December 2000 period was analyzed.
Abstract: In recent years, the validity of the weak form efficient market hypothesis (EMH) has been called into question as several studies have uncovered evidence that technical trading rules have predictive ability with respect to both developed and emerging stock market indices. This study analyses the forecasting power of 2 of the most popular trading rules using index data for a selection of 11 European stock markets over the January 1991 to December 2000 period. The findings indicate that the emerging markets included in this paper are informationally inefficient; these markets displayed some degree of predictability in their share returns, although the developed markets did not. Furthermore, the results point to large differences in the performance of the rules examined; while small size filters consistently outperformed the buy-and-hold strategy in the emerging markets examined even after the consideration of transaction costs, the performance of the moving average rules was erratic and varied dram...

Journal Article
TL;DR: This paper identified and characterised segments of individual investors based on their shared investing attitudes and behavior, including risk-intolerant traders, confident traders, loss-averse young traders, and conservative long-term investors.
Abstract: This study identifies and characterizes segments of individual investors based on their shared investing attitudes and behavior. A behavioral finance literature review reveals five main constructs that drive investor behavior: investment horizon, confidence, control, risk attitude, and personalization of loss. Ninety individual investors were surveyed via questionnaire on these constructs. A cluster segmentation analysis identified four main segments of individual investors: 1) risk-intolerant traders; 2) confident traders; 3) loss-averse young traders; and 4) conservative long-term investors. Each segment purchased different types of stocks, used different information sources, and had different levels of trading behavior.

Journal ArticleDOI
TL;DR: In this paper, the authors examined the implications of short-sales constraints and heterogeneous beliefs on stock prices and trading volume in China and found that trading caused by investors' speculative motive can help explain a significant fraction of the price difference between the dual-class shares.
Abstract: The market dynamics of technology stocks in the late nineties has stimulated a growing body of theories that analyze the joint effects of short-sales constraints and heterogeneous beliefs on stock prices and trading volume. This paper examines implications of these theories using a unique data sample from China, a market with stringent short-sales constraints and perfectly segmented dual-class shares. The identical rights of the dual-class shares allow us to control for stock fundamentals. We find that trading caused by investors' speculative motive can help explain a significant fraction of the price difference between the dual-class shares.

Journal ArticleDOI
TL;DR: A dynamic algorithmic decision making framework to assist investors determine the most appropriate algorithm given overall trading goals and investment objectives is provided.
Abstract: The emergence of algorithmic trading as a viable and often preferred execution mechanism has created a need for new suites of trading analytics to assist investors to compare, evaluate, and select appropriate algorithms. Unfortunately, many of the existing algorithms do not provide necessary transparency to make informed trading decisions. In this paper we provide a dynamic algorithmic decision-making framework to assist investors in determining the most appropriate algorithm given overall trading goals and investment objectives. The approach is based on a three step process where investors choose their price benchmark, select trading style (risk aversion), and specify adaptation tactic. The framework makes extensive use of the Almgren & Chriss (1999, 2000) efficient trading frontier.

Posted Content
TL;DR: In this paper, the authors studied the intraday market quality for currency pairs with very different trading characteristics, such as the Euro-U.S. dollar and the Canadian dollar, and found that the Euro market quality is highest during European trading and lowest during Asian trading.
Abstract: This paper studies intraday market quality for currency pairs with very different trading characteristics, the Euro-U.S. dollar and the Canadian dollar-U.S. dollar. Two sets of tests - the first based on the ratio of long term to short term variances, and the second based on information spillovers - provide consistent conclusions regarding market quality. The variance ratio analysis shows that market quality is highest for the Euro during European trading and lowest during Asian trading. For the Canadian dollar, market quality is highest during North American trading and lowest during Asian trading. Analysis of information spillovers shows that innovations in returns and volatility for the more heavily-traded Euro predict returns and volatility for the Canadian dollar during Asian and European trading, but innovations for the dollar have predictive power for the Euro during North American trading. Our results suggest that foreign exchange market quality is high, not always when quoting and trading activity are heavy but rather, and somewhat unexpectedly, when activity is not only high, but also geographically focused and concentrated among a limited number of major dealers.

Journal ArticleDOI
TL;DR: In this paper, the second-best trading ratio was derived for point-source and non-point trading in the Susquehanna River Basin. But the second best trading ratio in this case can only be second best, since program managers often do not have control over the number of permits.
Abstract: Most research on point‐nonpoint trading focuses on the choice of trading ratio (the rate point source controls trade for nonpoint controls), although the first-best ratio is jointly determined with the optimal number of permits. In practice, program managers often do not have control over the number of permits—only the trading ratio. The trading ratio in this case can only be second-best. We derive the second-best trading ratio and, using a numerical example of trading in the Susquehanna River Basin, we find the values are in line with current ratios, but for different reasons than those that are normally provided.

Journal ArticleDOI
TL;DR: In this article, the authors investigate the performance of call markets at the open and close using a unique natural experiment provided by the London Stock Exchange where traders can choose between a call and an off-exchange dealership system.
Abstract: We investigate the performance of call markets at the open and close using a unique natural experiment provided by the London Stock Exchange where traders can choose between a call and an off-exchange dealership system. Although the call market dominates dealers in terms of price discovery, it suffers from a high failure rate to open and close trading especially when trading conditions are difficult. The call's trading costs increase with asymmetric information, slow trading, order flow imbalances, and uncertainty. Traders' resort to use of call auctions is negatively correlated with firm size, implying that the call may not be the optimal method for opening and closing trading of medium and small sized stocks.

Journal ArticleDOI
TL;DR: In this paper, the authors argue that differences in the exclusivity, liquidity, anonymity, and post-trade transparency of each system permit a more efficient sorting of interdealer trades than if there were just one system.
Abstract: This article asks why London security dealers use more than one trading venue to trade with one another. We argue that differences in the exclusivity, liquidity, anonymity, and post-trade transparency of each system permit a more efficient sorting of interdealer trades than if there were just one system. Our evidence comes from detailed data on where London dealers chose to place interdealer trades. Contrary to intuition, we show that uninformed interdealer trades (as measured by subsequent price impact) tend to migrate to third-party brokered systems where trade is anonymous. By contrast, informed interdealer trades tend to migrate to the direct, nonanonymous public market. Additionally, we show that this distribution of trades is supported by differences in the price improvement dealers receive in the direct and brokered markets. Our findings have implications for three strands of the market microstructure literature. First, they contribute to our understanding of the importance of anonymity and transparency in securities trading. Most theoretical models of the effects of anonymity and transparency predict that anonymous trading systems will attract more informed trades

Posted Content
TL;DR: In 2003, several prominent mutual fund companies came under investigation for illegal trading practices, and several policy suggestions to prevent future trading abuses and provide direction for future research were discussed.
Abstract: In September 2003, several prominent mutual fund companies came under investigation for illegal trading practices Allegations suggested these funds allowed certain investors to profit from short-term trading schemes at the expense of other investors Surprisingly, regulatory authorities have known for more than two decades of the potential for such abuses, yet have taken limited steps to correct the problem We explore investor reaction to the scandal by measuring assets under management, stock returns, and performance Mutual funds managed by investigated firms show a substantial decline in post-announcement assets under management These firms also experienced significantly negative announcement-period returns Finally, we discuss several policy suggestions to prevent future trading abuses and provide direction for future research

Patent
04 Aug 2005
TL;DR: In this article, a method of managing trading is provided, where a determination is made of whether a particular trading order is an outlying trading order by determining whether the trading order differs from at least one comparison price by more than a threshold value.
Abstract: According to one embodiment, a method of managing trading is provided. In a market for a particular type of instrument, buy orders and sell orders are received from a plurality of traders. Each buy order has an associated bid price and each sell order has an associated offer price. A determination is made of whether the particular trading order is an outlying trading order by determining whether the particular trading order differs from at least one comparison price by more than a threshold value. If it is determined that the particular trading is an outlying trading order, a restrictive action is taken regarding the outlying trading order. For example, if a trader subsequently submits another trading order that would trade with the outlying trading order, an alert message may be sent to the trader and the subsequent trading order may be prevented from trading with the outlying trading order at least temporarily.

Journal ArticleDOI
TL;DR: The authors examined whether managers' trading decisions (both at a firm and personal level) are correlated with trading strategies suggested by the operating accruals and the post-earnings announcement drift.
Abstract: We examine whether managers' trading decisions (both at a firm and personal level) are correlated with trading strategies suggested by the operating accruals and the post-earnings announcement drift (SUE) anomalies. We discuss advantages and disadvantages of the use of managerial trading activity to infer managers' private valuation about their own securities. Our results provide corroborative evidence for the accruals anomaly, i.e., managers' repurchase and insider trading behavior varies consistently with the information underlying the operating accruals trading strategy. On the other hand, we do not find corroborative evidence for the SUE anomaly.

Journal ArticleDOI
TL;DR: Algorithmic trading is found to be a cost-effective technique, based on a measure of implementation shortfall, and the superiority of algorithm performance applies only for order sizes up to 10% of average daily volume; however, certainty of outcome declines sharply with the size of the order.
Abstract: The authors examine transaction costs associated with algorithmic trading, based on a sample of 2.5 million orders, of which one million are executed via algorithmic means. The data permit a comparison of algorithmic executions with a broader universe of trades, as well as across multiple providers of model-based trading services. Algorithmic trading is found to be a cost-effective technique, based on a measure of implementation shortfall. The superiority of algorithm performance applies only for order sizes up to 10% of average daily volume, however. Algorithmic trading performance relative to a commonly used volume participation benchmark also is quite good, although certainty of outcome declines sharply with the size of the order. A clear link between performance and variability in performance relative to both benchmarks appears to be lacking. Although rough equality across providers is observed on average, this equality of performance breaks down quickly as order size grows.

Journal ArticleDOI
TL;DR: Results are positive, robust, systematic, economically significant, and informative as to the role of trading volume in the stock market mechanism.
Abstract: We identify trading volume spikes through use of the template matching technique from statistical pattern recognition. For those trading days meeting the condition signifying volume spike recognition, application of linear regression models the future change in price using historical price and prime interest rate values. Also, we train a nonlinear neural network model and use it as a basis for simulated trading, which includes consideration of transaction costs and cash dividends. We illustrate and test with New York Stock Exchange Composite Index data for the period from 1981 to 1999. Results are positive, robust, systematic, economically significant, and informative as to the role of trading volume in the stock market mechanism.

Journal ArticleDOI
TL;DR: In this paper, the authors examine the properties of financial market dynamics, under different trading protocols, and highlight the importance of the institutional setting in shaping the dynamics of the market but also suggest that the latter can become the outcome of a complicated interaction between the trading protocol and the ecology of traders behaviors.