Enhancing liquidity in Emerging Market Exchanges

This is a study by the World Federation of Exchanges in cooperation with consulting firm Olivier Wyman.

The report, entitled Enhancing Liquidity in Emerging Market Exchanges, is designed to provide regulators and exchange operators in emerging markets with ideas around how to grow and enhance market liquidity - liquidity levers - and a potential framework for which of those levers may work best at which stage of market development. Many emerging markets suffer from low levels of liquidity, effectively placing a constraint on economic and market development. Liquidity is positively associated with broader market development, and often creates a virtuous circle, resulting in encouraging effects for the underlying economy.

Read the full report here

Limit Order Placement by High-Frequency Traders

This study, conducted by the University of California and the University of Sydney used a unique dataset consisting of limit order placement, execution, and cancellations on Nasdaq to examine liquidity provision by high-frequency trading (HFT) firms, which is a central issue in the ongoing debates about HFT.

The study shows that HFT firms more effectively use order cancellation to strategically manage their limit orders in anticipation of short-term price movements than non-HFT firms. HFT firms increase their liquidity provision during periods of high volatility; their liquidity provision is less affected by order imbalance shocks than that of non-HFT firms.

Overall, the results indicate that HFT limit orders exert a stabilizing influence on markets.

Read the full study here.

FSB progress report on OTC market reform

This progress report provides an update on the implementation of the post-crisis reforms for over-the-counter (OTC) derivative markets. Since the previous progress report in July, some additional steps have been taken in a few jurisdictions to implement frameworks for reforms. Nineteen of 24 FSB jurisdictions have in force trade reporting requirements covering over 90% of transactions in their markets. Reforms are also advancing, but more slowly, to promote central clearing and platform trading, where appropriate, for standardised contracts. Almost all jurisdictions have in force higher capital requirements for non-centrally cleared derivatives, but most are only in the early phases of implementing the BCBS-IOSCO framework for margin requirements for such transactions. The report also gives a brief update on developments in international workstreams that support the implementation of OTC derivatives market reforms. 

You can find the report here

FSB report on OTC derivatives Trade Reporting

This peer review provides an update on the implementation of G20 requirements for trade reporting in over-the-counter (OTC) derivative markets. It shows the majority of FSB member jurisdictions have trade reporting requirements in place and calls on jurisdictions that have not fully implemented reporting requirements to do so promptly. Legal and regulatory barriers to complete reporting continue to be a concern. FSB members have agreed that jurisdictions should address legal barriers to reporting by June 2018, that masking of counterparty-identifying data be discontinued by end-2018, and that by June 2018 at the latest all jurisdictions should have legal frameworks in place to permit access to data held in a domestic trade repository by relevant authorities (whether domestic or foreign). There remain a number of challenges in the quality and usability of trade repository held data. Notwithstanding these challenges, some authorities are starting to make good use of data for some regulatory purposes.

You can find the report here

On the Impossibility of Informationally Efficient Markets

A paper written in 1980 but still relevant to this day and age as it discusses the (im)possibility of an EMH (Efficient Market Hypothesis)..

In this paper, Grossman & Stiglitz from the University of Pennsylvania argues that as information is costly, prices cannot perfectly reflect the information which is available, since if it did, those who spent resources to obtain it would receive no compensation, leading to the conclusion that an informationally efficient market is impossible.

Read the full paper here.


HFT around large II orders

When high-frequency traders (HFTs) enter markets, the bid-ask spread declines. Several academic studies have reported such a result. Investors pay less for each market order they send. All good and everyone happy. 


Vincent van Kervel and Albert J. Menkveld have done the research and present the facts in a well written paper. There is also the blog by Albert Menkveld This paper is good, and often much needed, factual input for discussions about market structure.

Ultra-Fast Activity and Market Quality


"We use order and trade messages sent to NASDAQ, every March 2005–2013, to build a measure of ultra-fast activity (UFA) which captures the times when trading algorithms are most active. Our results suggest, quite consistently, that UFA is associated with lower liquidity in stock markets. An increase in UFA leads to greater quoted and effective spreads and lower depth posted in the limit order book. For example, in 2013 we find that a 1 standard deviation increase in our measure of UFA is associated with a 0:13 standard deviation increase in the quoted spread. UFA causes similar increases in effective spreads and also reduces quoted depth. Finally, the effect of UFA is also economically significant. For example, in March 2013 the effect of a one standard deviation in UFA generated on average an increase of between 3 and 6 percent in the quoted spread and effective spreads, as well as a drop of between 3 and 4 percent for depth measured close to the best bid and ask prices."

Click here to find the study.

Geopolitics for investors by Pippa Malmgrem

Geopolitical issues have a profound effect on investment strategies and results. Investors inevitably must balance risk and reward. Geopolitics can bring both risks and opportunities, large and small, onto the investment landscape. The question is, How much time and effort can be devoted to this particular task? Prediction is nearly impossible but preparedness is attainable and desirable. Fund managers and investors need to ask whether preparedness is best achieved through scenario planning, by including geopolitics as one of many drivers of the investment strategy, or by changing the investment team or the information sources and services that the team uses. As always, markets represent diverse interests and abilities. Some investors will find a way to add geopolitics to their investment scenarios and to profit from it. Others will take comfort in knowing that they were not alone in utterly ignoring geopolitics. This monograph offers some core ideas about how to think about the subject. These ideas may prove useful as geopolitics returns to the investment landscape with increasing force.

Find the report here.

The new stock market; sense and nonsense


How stocks are traded in the United States has been totally transformed. Gone are the dealers on NASDAQ and the specialists at the NYSE. Instead, a company’s stock can now be traded on up to sixty competing venues where a computer matches incoming orders. A majority of quotes are now posted by high-frequency traders (HFTs), making them the preponderant source of liquidity in the new market.

Many practices associated with the new stock market are highly controversial, as illustrated by the public furor following the publication of Michael Lewis’s book Flash Boys. Critics say that HFTs use their speed in discovering changes in the market and in altering their orders to take advantage of other traders. Dark pools – off-exchange trading venues that promise to keep the orders sent to them secret and to restrict the parties allowed to trade – are accused of operating in ways that injure many traders. Brokers are said to mishandle customer orders in an effort to maximize the payments they receive in return for sending trading venues their customers’ orders, rather than delivering best execution. 

In this paper, the researchers set out a simple, but powerful, conceptual framework for analyzing the new stock market. The framework is built upon three basic concepts: adverse selection, the principal-agent problem, and a multi-venue trading system. We illustrate the utility of this framework by analyzing the new market’s eight most controversial practices. The effects of each practice are evaluated in terms of the multiple social goals served by equity trading markets.  

They ultimately conclude that there is no emergency requiring immediate, poorly-considered action. Some reforms proposed by critics, however, are clearly desirable. Other proposed reforms involve a tradeoff between two or more valuable social goals. In these cases, whether a reform is desirable may be unclear, but a better understanding of the tradeoff involved enables a more informed choice and suggests where further empirical research would be useful. Finally, still other proposed reforms are based on misunderstandings of the market or of the social impacts of a practice and should be avoided.

The study can be found here.


Robustness of Smart Beta Strategies

In this study by EDHEC, the authors demonstrate that there has been significant evidence that systematic equity investment strategies (so-called smart beta strategies) outperform cap-weighted benchmarks in the long run.

Concerning actual investment decisions, it is relevant to question how robust the outperformance is. The paper makes a distinction between relative robustness and absolute robustness. A strategy is assumed to be ‘relatively robust’ if it is able to deliver similar outperformance under similar market conditions by aligning well with the performance of underlying factor exposure it is seeking and reducing unrewarded risks.

Absolute Robustness is the absence of pronounced state and/or time dependencies and a strategy shown to outperform irrespective of prevailing market conditions can be termed as robust in absolute terms The paper goes on to review the importance of robustness for smart beta strategies, it explains various methods by which smart beta strategies try to improve robustness, and discusses how to measure and assess robustness in the performance analysis of smart beta strategies. 

Read the full study here

Scientific Beta Multi-Strategy Factor Indices

Scientific Beta Multi-Strategy Factor Indices: Combining Factor Tilts and Improved Diversification

This paper by EDHEC argues that current smart beta investment approaches only provide a partial answer to the main shortcomings of cap-weighted indices, and introduces Scientific Beta Multi-Strategy Factor Indices which are constructed using a new approach to equity investing referred to as smart factor investing.

It then provides an assessment of the benefits of addressing the two main problems of cap-weighted indices (their undesirable factor exposures and their heavy concentration) simultaneously by constructing factor indices that explicitly seek exposures to rewarded risk factors, while diversifying away unrewarded risks.

The results suggest that ERI Scientific Beta Multi-Strategy Factor Indices lead to considerable improvements in risk-adjusted performance. For long-term US data, smart factor indices for a range of different factor tilts consistently outperform cap-weighted factor tilted indices, and factor indices from popular commercial index providers. Compared to the broad cap-weighted index, smart factor indices roughly double the risk-adjusted return (Sharpe ratio). Outperformance of such indices persists at levels ranging from 2.92% to 4.46% annually, even when assuming unrealistically high transaction costs. Moreover, by providing explicit tilts to consensual factors, such indices improve upon many current smart beta offerings where, more often than not, factor tilts result as unintended consequences of ad hoc methodologies.

Read the full study here

Calculating tail risk in Fixed Income markets

In this study, the researchers from the Cheung Kong Graduate School of business constructed a model-free measure of tail risk for Fixed income markets using a proprietary dataset of swaptions, denoted as TAIL, which captures the price of insuring against extreme movements in interest rate swap rates.

The researchers show that TAIL closely tracks the variations in tail risk in the economy and has strong predictive power for returns on Treasury bonds, corporate bonds, mortgage-backed securities, Fixed-income hedge funds, and even equities, suggesting that interest rate tail risk is universally priced in all major Finanancial markets.

Read the full study here

The role of HFT in Order Book Resiliency

This paper from the Goethe institute in Frankfurt explores limit order book resiliency following liquidity shocks in the presence of high-frequency trading firms.

Based on a unique data set that enables the identification of orders submitted by algorithmic traders and subscribers of co-location services, they studied whether high-frequency traders are involved in the reconstruction of the order book.

The researchers analyzed order submission and deletion activity before and after a liquidity shock initiated by a large market order. The results show that exclusively HFT reduces the spread within the first seconds after the market impact making use of their speed advantage. However, liquidity recovery in terms of order book depth takes significantly longer and is accomplished by human traders' submission activity only.

Read the full study here

HFT with online learning

In this study, the author proposes an optimization framework for market-making in a limit-order book, based on the theory of stochastic approximation. The idea is to take advantage of the iterative nature of the process of updating bid and ask quotes in order to make the algorithm optimize its strategy on a trial-and-error basis (i.e. on-line learning). An advantage of this approach is that the exploration of the system by the algorithm is performed in run-time, so explicit specifications of the price dynamics are not necessary, as is the case in the stochastic-control approach.

Read the full study here

High-Frequency Trading and Its Role in Fragmented Markets

In this study, conducted by Martin Haferkorn of the Goethe University in Frankfurt, the researchers looked into the effect HFT had on price dispersion in fragmented markets. For this, they compared long term blue chip data from Euronext Paris, Deutsche Boerse and BATS-CHi-X to measure the effect of investments made in IT infrastructure (HFT trading).

The conclusion is that HFT increases market efficiency and that the introduction of the German HFT act increased price dispersion between BATS-Chi-X and Deutsche Boerse in blue chip stocks

Read the full study here

Using sentiment data to develop a trading strategy

In this paper, Ronald Hochreiter of the Vienna University computed trading strategies based on market sentiment derived from the postings of stocktwits, one of the largest social media accounts following the developments on financial markets. It's a very good example of how data from social media can be used to implement trading strategies.

Read the full study here.



Using short selling and hedge fund positions as predictive powers

In this study, the researchers from the Bejiing School of finance exploit the information contained in the joint analysis of the long and short sides of hedge fund trading. They state that opposite changes in short interest and hedge fund holdings are likely driven by information, whereas simultaneous increases (decreases) in short interest and hedge fund holdings are likely motivated by hedging (unwinding) incentives. This intuition allows to utilize short selling and hedge fund holding information to identify informed long and short demand.
Using this identification strategy, the researchers show that informed demand changes have high predictive power for returns.

Read the full study here