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Friday, April 04, 2014

'The Legitimacy of High Frequency Trading'

Tim Johnson on high frequency trading:

The Legitimacy of High Frequency Trading: Mark Thoma brought my attention to a post by Dean Baker, High Speed Trading and Slow-Witted Economic Policy. High Frequency Trading, or more generically Computer Based Trading, is proving problematic because it is a general term involving a variety of different techniques, some of which appear uncontroversial, others appear very dubious.

For example, a technique I would consider legitimate derives from Robert Almgren and Neil Chriss' work on optimal order execution: how do you structure a large trade such that it has minimal negative price impact and low transaction costs. There are firms that now specialise in performing these trades on behalf of institutions and I don't think there is an issue with how they innovate in order to generate profits.

The technique that is most widely regarded as illegitimate is order, or quote, stuffing. The technique involves placing orders and within a tenth of a second or less, cancelling them if they are not executed. I suspect this is the process that Baker refers to that enables HFTs to 'front run' the market. Baker regards the process as illegitimate...

The problem I have with Baker's argument is that I do not think it is robust. ... [explains why] ...

The substantive question is whether I can come up with a more robust argument than Baker's, and I offer an argument at the bottom of this piece. ...

    Posted by on Friday, April 4, 2014 at 08:34 AM in Economics, Financial System | Permalink  Comments (23)

          


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