THE HANDBOOK OF HIGH FREQUENCY TRADING

The Handbook of HIGH FREQUENCY TRADING GREG N. GREGORIOU State University of New York (Plattsburgh) Amsterdam • Boston • Heidelberg • London New York • Oxford • Paris • San Diego San Francisco • Singapore • Sydney • Tokyo Academic Press is an imprint of Elsevier Academic Press is an imprint of Elsevier 125 London Wall, London EC2Y 5AS, UK 525 B Street, Suite 1800, San Diego, CA 92101-4495, USA 225 Wyman Street, Waltham, MA 02451, USA The Boulevard, Langford Lane, Kidlington, Oxford OX5 1GB, UK Copyright © 2015 Elsevier Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the publisher. 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To the fullest extent of the law, neither the Publisher nor the authors, contributors, or editors, assume any liability for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions, or ideas contained in the material herein. ISBN: 978-0-12-802205-4 British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Catalog Number A catalog record for this book is available from the Library of Congress For information on all Academic Press publications visit our website at http://store.elsevier.com/ Typeset by TNQ Books and Journals www.tnq.co.in Printed and bound in USA LIST OF CONTRIBUTORS Erdinç Akyıldırım Akdeniz University, Faculty of Economics and Administrative Sciences, Antalya, Turkey Paul U. Ali Melbourne Law School, Parkville, Melbourne, VIC, Australia David E. Allen School of Mathematics and Statistics, University of Sydney, and School of Business, University of South Australia, Australia Albert Altarovici ETH Z€urich, Department of Mathematics, Z€urich, Switzerland Richard G. Anderson School of Business and Entrepreneurship, Lindenwood University, St Charles, MO, USA Jane M. Binner Department of Accounting and Finance, Birmingham Business School, University of Birmingham, Birmingham, UK Kris Boudt Solvay Business School, Vrije Universiteit Brussel, Brussels, Belgium Godfrey Charles-Cadogan School of Economics, UCT, Rondebosch, Cape Town, South Africa Giuseppe Ciallella Law and Economics, LUISS Guido Carli, Rome, Italy Brittany Cole University of Mississippi, School of Business, University, MS, USA Imma Valentina Curato Ulm University, Ulm, Germany Jonathan Daigle University of Mississippi, School of Business, University, MS, USA Nazmi Demir Department of Banking & Finance, Bilkent University, Bilkent, Ankara, Turkey Cumhur Ekinci ITU Isletme Fakultesi - Macka, Istanbul, Turkey Dov Fischer Brooklyn College, School of Business, Brooklyn, NY, USA Nikola Gradojevic Lille Catholic University, I  ESEG School of Management, Lille, France xiii Greg N. Gregoriou State University of New York (Plattsburgh), NY, USA George Guernsey Managing Partner, Insight Mapping, St. Louis, MO, USA Bj€orn Hagstr€omer School of Business, Stockholm University, Stockholm, Sweden Tobias Hahn Bond University, Gold Coast, QLD, Australia Kin-Yip Ho Research School of Finance, Actuarial Studies and Applied Statistics, ANU College of Business and Economics, The Australian National University, Canberra, ACT, Australia Hooi Hooi Lean Economics Program, School of Soc ial Sciences, Universiti Sains Malaysia, Penang, Malaysia Camillo Lento Faculty of Business Administration, Lakehead University, Thunder Bay, ON, Canada François-Serge Lhabitant CEO and CIO, Kedge Capital, Jersey; EDHEC Business School, Nice, France Jeffrey G. MacIntosh University of Toronto, Faculty of Law, Toro nto, ON, Canada Michael J. McAleer Department of Quantitative Finance, College of Technology Management, National Tsing Hua University, Hsinchu, Taiwan, and Econometric Institute, Erasmus School of Economics, Erasmus University, Rotterdam, The Netherlands David R. Meyer Olin Business School, Washington University in St. Louis, St. Louis, MO, USA Vinod Mishra Department of Economics, Monash University e Berwick Campus, Berwick, VIC, Australia Imad Moosa School of Economics, Finance and Marketing, RMIT, Melbourne, VIC, Australia Giang Nguyen Solvay Business School, Vrije Universiteit Brussel, Brussels, Belgium Birger Nilsson Department of Economics, Lund University, Sweden Benedict Peeters Finvex Group, Brussels, Belgium Vikash Ramiah School of Economics, Finance and Marketing, RMIT, Melbourne, VIC, Australia Erick Rengifo Fordham University, Bronx, NY, USA xiv List of Contributors Simona Sanfelici Department of Economics, University of Parma, Parma, Italy Martin Scholtus Econometric Institute and Tinbergen Institute, Erasmus University Rotterdam, Rotterdam, The Netherlands Tayyeb Shabbir Department of Finance, CBAPP, California State University Dominguez Hills, Carson, CA, USA and Department of Finance, Wha rton School, University of Pennsylvania, Philadelphia, PA, USA Yanlin Shi Research School of Finance, Actuarial Studies and Applied Statistics, ANU College of Business and Economics, The Australian National University, Canberra, ACT, Australia Abhay K. Singh School of Business, Edith Cowan University, Joondalup, WA, Australia Russell Smyth Department of Economics, Monas h University, Clayton, VIC, Australia M. Nihat Solakoglu Department of Banking & Finance, Bilkent University, Bilkent, Ankara, Turkey Masayuki Susai Nagasaki University, Nagasaki, Japan Rossen Trendafilov Department of Economics, Truman State University, Kirksville, MO, USA Dick van Dijk Econometric Institute and Tinbergen Institute, Erasmus University Rotterdam, Rotterdam, The Netherlands Bonnie F. Van Ness University of Mississippi, School of Business, University, MS, USA Robert A. Van Ness University of Mississippi, School of Business, University, MS, USA Bruce Vanstone Bond University, Gold Coast, QLD, Australia Camillo von M€uller CLVS-HSG University of St. Gallen, St. Gallen, Switzerland Yushi Yoshida Shiga University, Hikone, Japan Zhaoyong Zhang School of Business, Faculty of Business and Law, Edith Cowan University, Joondalup, WA, Australia List of Contributors xv CONTRIBUTORS BIOGRAPHIES Erdinç Akyıldırım is a researcher and product developer at Borsa Istanbul. Prior to Borsa Istanbul, he w orked as a quantitative analyst and derivatives portfolio manager at Industrial Devel- opment Bank of Turkey and as a research and teaching assistant at Bogazici University, Sabanci University, and Swiss Federal Institute of Technology in Zurich. He received a BSc degree in mathematics and MSc degree in financial engineering from Bogazici University. He completed his PhD in banking and finance at University of Zurich and Swiss Finance Institute in 2013. Dur- ing his PhD, he worked on topics related to financial engineering, financial mathematics, and financial econometrics and has published several papers in international journals and conferences. Paul U. Ali is Associate Professor at Melbourne University Law School and a member of the Law School’s Centre for Corporate Law and Securities Regulation. Paul has published widely on banking and finance law. Paul has worked in the banking and finance and corporate groups of two leading Australian law firms. He has also worked in the securitization team of a bank, and has been a principal of a private capital firm and a consultant with a corporate governance advisory firm. David E. Allen has a PhD in finance from the University of Western Australia, plus an MPhil in economics from the University of Leicester. In the course of the last 39 years, he has been employed by De Montfort University and the University of Edinburgh in the UK, and the Uni- versity of Western Australia, Curtin University, and Edith Cowan University in Western Australia where he was Foundation Professor of Finance. He is curren tly Visiting Professor in the School of Mathematics and Statistics at the University of Sydney and Adjunct Professor at the University of South Australia. He has published 3 books and over 100 other contributions to books and refereed journal publications. Albert Altarovici is a PhD student in mathematics at ETH Zurich. He specializes in stochastic optimal control and its applications to finance. In a recent paper with J. Muhle-Karbe and H.M. Soner, he studies the asymptotic expansion for the problem of optimal consumption and invest- ment in a market with multiple risky assets, which are correlated Brownian motions and a money market paying constant interest rate where every transactio n incurs a fixed transaction cost. He has taught mathematics and finance at the University of Virginia and ETH Zurich. Richard Anderson is senior research fellow, Center for Economics and the Environment, and Adjunct Professor, School of Business and Entrepreneurship, Lindenwood University, St Charles, Missouri. Previously, he was vice president and economist, Federal Reserve Bank of St Louis, and economist, Board of Governors of the Federal Reserve System, Washington, D.C. Prior to joining the Federal Reserve, he taught at Michigan State University, Ohio State University, and the University of Michigan. He holds a PhD from MIT and a BA in economics from the University of Minnesota. His research focuses on empirical macroeconomics and monetary policy. xvii Jane M. Binner is Chair of finance, accounting and finance department, Birmingham Business School, Birmingham University, UK. Previously, she was Head of the Accounting and Finance Division at Sheffield Management School, Sheffield, UK and Reader in economics, Aston Busi- ness School, Birmingham, UK. She holds PhD, MSc, PGCE, and BA Hons in economics from the University of Leeds. Her research focuses on econometric modeling of financial markets, including asset prices and monetary aggregates. Kris Boudt is Associate Professor in finance at Vrije Universiteit Brussel and part-time at the econometrics and finance department of the VU University of Amsterdam. He is a research part- ner of Finvex Group and affiliated researcher at KU Leuven. By training he has an MSc degree in economics from the University of Namur and a PhD from the KU Leuven (2008). Previously, he was Assistant Professor at the KU Leuven (2009e2012) and Guest Lecturer at the University of Illinois at Chicago. The research of Kris Boudt aims at developing econometric methodolog y for analyzing financial markets and optimizing portfolio risk. He has published in leading interna- tional finance and statistics journals including the International Journal of Forecasting, Journal of Empirical Finance, Journal of Financial Econometrics, Journal of Financial Markets, Journal of Risk, and Statistics and Computing, among others. Kris Boudt is in the editorial board of quantitative finance letters and is a coauthor of the high-frequency and PortfolioAnalytics packages. Godfrey Charles-Cadogan is a Research Scientist in risk and uncertainty at the Institute for Innovation and Technology Management (IITM), Ted Rogers School of Management, Ryerson University. His work has been featured in Financial Research Letters, System Research and Behavioural Science, Proceedings of the American Statistical Association Business & Economics Section, Proceedings of Foundations and Applications of Utility, Risk and Decision Theory, Money Science, All About Alpha, and High Frequency Trading Review. He is the creator of the Cadogan stock price formula for high-frequency trading, and criterion function for predicting market crash from the probability weighting function implied by index option prices. His research interests are behavioral stochastic processes, financial economics, experimental economics, and decision theory. He holds Bachelor of Science degrees in statistics and actuarial mathematics as well as a Master of Science degree in mathematical statistics from the University of Michigan, and is a PhD candidate in economics at the University of Cape Town in Mathematical Beha vioral Economics. Giuseppe Ciallella graduated with honors at LUISS Guido Carli (Rome) Law School in 2009 and then spent one year as research assistant in Company Law and Securities Regulation at the same university. In 2012, he got an LL.M. from the London School of Economics and Political Science on a “Donato Menichella” Scholarship by the Bank of Italy. His PhD at LUISS Guido Carli is in Law and Economics and his field of research is Banking and Financial Regulation. Dur- ing his PhD he also worked at Goldman Sachs International, Milan, and at Cleary Gottlieb Steen and Hamilton LLP, Rome. Brittany Cole is a fifth year finance PhD student at the University of Mississippi. She received a bachelors degree in agriculture economics from the University of Tennessee at Martin and an MBA from the University of Miss issippi. Brittany’s research interests include corporate and municipal bond trading, informatio n transmission, and market microstructure. Imma Valentina Curato holds a PhD in mathematics for economic decisions from the Univer- sity of Pisa, Italy. Currently, she is a Postdoc student at the Institute of Mathematical Finance, Ulm xviii Contributors Biographies University, Germany, and an external consultant at the European Central Bank, Frankfurt, Ger- many. Her main research interests are in the field of nonparametric econometrics: estimation of volatility; of leverage processes in univariate and multivariate frameworks, high-frequency data analysis, calibration/forecast performance of multifactor stochastic volatility models; and of liquidity risk factors models. Jonathan Daigle is a fourth year fi nance PhD student at the University of Mississippi. He received his undergraduate degree and MBA from the University of South Alabama. His research interests include private equity, IPOs, and acquisitions. Nazmi Demir received his MSc and PhD from the University of Ca lifornia, Davis in agricultural economics in 1970 and his associate professorship in economic policy in Turkey, in 2000. Nazmi specialized in Leontief inputeoutput, inefficiency models, and environments in agricultural eco- nomics. He was a board member of various international research centers for 18 years. After a long-term government employment at high positions in various departments such as develop- ment planning, agrarian reform, and administrative duties in Turkey he joined Bilkent University in the Department of Economics as an instructor first and then as a chairman of the banking and finance department teaching micro- and macroeconomics, statistics, banking, and finance. He has published numerous books and papers in Developing Economies, Economic Letters, Canadian Journal of Agricultural Economics, and Economic Systems Research. Cumhur Ekinci is Assistant Professor of financ e at Istanbul Technical University (ITU). He studied eco nomics and finance at Bogazici, Paris I Pantheon-Sorbonne and Aix-Marseille III. Dr Ekinci established and worked in a trading room at CNAM in Paris. He has been teaching financial markets, investment, corporate finance and accounting at ITU, CNAM, Aix-Marseille, and ENPC. His research includes topics in market microstructure, behavioral finance, and risk measurement. Dov Fischer is Assistant Professor of accounting at Brooklyn College. He holds a doctorate in accounting from University of Colorado at Boulder, and is a CPA in New York State. He researches financial reporting in the banking and pharmaceutical industries, financial derivatives, accounting ethics, International Financial Reporting Standards (IFRS), and accounting educa- tion. His research has been recognized and awarded by the American Accounting Association, and he regularly publishes in academic and practitioner journals, incl uding CPA Journal; Journal of Business & Economic Studies; Journal of Accounting, Ethics, and Public Policy; and Journal of Religion & Business Ethics. Nikola Gradoje vic received the PhD degree in financial economics from the University of British Columbia, Vancouver, BC, Canada, in 2003. He also holds an MA in economics from University of Essex and Central European University and an MSc in electrical engineering (Sys- tem Control Major). Currently, he is Associate Professor of finance at the I  ESEG School of Man- agement, Lille Catholic University, in Lille and Paris, France. During his career, he took positions at the University of British Columbia, Bank of Canada, Federal Reserve Bank of St Louis, Lake- head University, and in the private sector as a consultant in the financial and mining industries. He has held visiting appointments at Rouen Business School in France, University of Bologna in Italy, Faculty of Economics in Montenegro and University of Novi Sad, Faculty of Technical Sci- ences. He is currently a research fellow at the Rimini Center for Economic Analysis in Italy and Contributors Biographies xix Visiting Professor at the University of Essex (The Centre for Computational Finance and Economic Agents) in the United Kingdom. Dr Gradojevic’s research interests include empirical asset pricing, market microstructure, high-frequency finance, international finance, nonadditive entropy, artificial intelligence (e.g., neural networks and fuzzy logic), technical trading, asset price volatility and bubbles. He has published his research in journals, such as Journal of Banking and Finance, Journal of Empirical Finance, Quantitative Finance, Journal of Economic Dynamics and Control, Finance Research Letters, IEEE Signal Processing Magazine, IEEE Transactions on Neural Networks, Physica D, and Journal of Forecasting. George Guernsey is Managing Partner of Insight Mapping. He served as group head of strategy, risk and financial reporting at two international banks and two global consulting firms, providing growth strategies to bank s and exchanges. Based in London for 17 years, he then developed risk products and strategies for banks and technology companies in Europe and Asia. He cofounded Strategic Insig hts, a competitive intelligence resource, then launching and directing its Insight Mapping market radar service. Insight Mapping employs customized versions of systems devel- oped for government intelligence services to target emerging threats and opportunities for com- panies and financial insti tutions. Early identification provides a competitive advantage for executives seeking to spot needs, design new products and services, mitigate risks, and go to mar- ket effectively. He has a BA in political science and economics from Yale University and an MBA with distinction from the Wharton School of the University of Pennsylvania. Bj€orn Hagstr€omer is Associate Professor, Stockholm Business School, Stockholm University, Sweden. He holds a PhD from Aston Business School, Birmingham, UK. His research focuses on empirical asset pricing and empirical market microstructure, including high-frequency trading. Tobias Hahn holds a PhD in computational finance from Bond University. His PhD thesis investigated the application of machine learning to options pricing. He is an active academic researcher, and has practical experience in financial analysis and trading systems development. Tobias’s current research interests focus on the modeling of high-frequency financial time series, asset pricing, and model evaluation. Kin-Yip Ho is currently Assistant Professor at the Research School of Finance, Actuarial Studies and Applied Statistics in The Australian National University. He has held visiting positions, including a fellowship from the Korea Institute of International Economic Policy (KIEP) to work on a research project involving the Chinese financial markets. He has published articles in various international journals, such as Annals of Actuarial Science, Annals of Financial Economics, China Economic Review, Economie Internationale, Japan and the Wor ld Economy, Journal of Appl ied Econometrics, Journal of Economic Development, Journal of Wealth Management, Mathematics and Com- puters in Simulation, North American Journal of Economics and Finance, Review of Financial Economics, and World Economy. He has also published several book chapters on Asian financial market s in the Handbook of Asian Finance. His current research interests lie in the actuarial applications of finan- cial and statistical models, financial econometrics, international finance, and time series analysis. He graduated with a PhD in economics from Cornell University and has an Associate Diploma in Piano Performance from London College of Music. Hooi Hooi Lean is Associate Professor at the School of Social Sciences (economics program), Universiti Sains Malaysia. She has published more than 80 book chapters and journal articles in xx Contributors Biographies many reputed international journals. Dr Lean is listed in the Who’s Who in the World 2009 and Researcher of the Week in GDNet East Asia. She was awarded the ASEAN-ROK Academic Exchange Fellowship Program in 2007, the Democratic Pacific Union Visi ting Fellowship in 2008, and the International HERMES Fellowship Program in 2009. Dr Lean also won the “Sanggar Sanjung” Excellence Award for Publication, since 2009 and the “Hadiah Sanjungan” Award for Best Publication, since 2006. There are 1132 citations to her research on Google Scholar. Camillo Lento is Associate Professor of accounting in the Faculty of Business Administration at Lakehead University. He received his PhD from the University of Southern Queensland, and both his masters (MSc) degree and undergraduate degree (HBComm) from Lakehead University. He is a Chartered Accountant (Ontario), Certified Fraud Examiner, and Chartered Business Val- uator. Dr Lento has published numerous articles and book chapters on technical trading models and capital markets. In addition, he is the lead author of the financial accounting casebook entitled Cases in Financial Accounting. Dr Lent o is also Contributing Editor for Canadian MoneySaver magazine and has authored numerous articles on personal tax planning matters. His tax planning articles have also been featured in many national media outlets. Dr Lento teaches various financial accounting and auditing courses, including contemporary issues in accounting theory, advanced topics in accounting, intermediate accounting, and introductory accounting. Dr Lento continues to practice in the area of accounting, business valuation, and economic loss quantification. François-Serge Lhabitant is currently the CEO and CIO of Kedge Capital, where he oversees more than $6 billion of capital invested in hedge funds and risk-controlled strategies. He was formerly a member of senior management at Union Bancaire Privie, where he was in charge of quantitative risk management and subsequently, of the quantitative analysis for alternative port- folios. Prior to this, François-Serge was Director at UBS/Global Asset Management, in charge of building quantitative models for portfolio management and hedge funds. On the academic side, François-Serge is currently Professor of finance at the EDHEC Busine ss School (France) and Visiting Professor at the Hong Kong University of Science and Technology. François holds an engineering degree from the Swiss Federal Institute of Technology, a BSc in economics, an MSc in banking and finance, and a PhD in finance from the University of Lausanne. Jeffrey MacIntosh is the Toronto Stock Exchange Chair of Capital Ma rkets at the Faculty of Law, University of Toronto, and is a past Associate Director and Director of the Capital Markets Institute at the University of Toronto. He specializes in corporation law and finance, securities regulation, venture capital financing, and innovation. He holds law degrees from Harvard and Toronto, and a Bachelor of Science degree from MIT. Professor MacIntosh was appointed a John M. Olin Fellow in law and economics at Yale Law School in 1988e1989. He also served as a member of the Ontario Securities Commission Task Force on small business financing. Pro- fessor MacIntosh is the coauthor (with Chris Nicholls) of Essentials of Securities Regulation (Tor- onto: Irwin Law Inc., 2002) and has published numerous articles, book chapters, and commentaries on various topics in his areas of expertise. Michael J. McAleer holds a PhD in economics from Queen’s University, Canada. He is Chair Professor of quantitative finance, National Tsing Hua University, Taiwan ; Professor of quantita- tive finance, Econometric Institute, Erasmus School of Economics, Erasmus Univ ersity Contributors Biographies xxi [...]... order-cancellation rate increased The Handbook of High Frequency Trading ISBN 978-0-12-802205-4, http://dx.doi.org/10.1016/B978-0-12-802205-4.00001-4 © 2015 Elsevier Inc All rights reserved 3 4 The Handbook of High Frequency Trading by 17.2%.1 Another recent technological change on the NYSE is the introduction of the hybrid market, designed to automate executions and increase trading speed However, Hendershott... beginning of system hours, must be empty again at the end of the day From June 5, 2009 to August 31, 2009 it was possible to use so-called flash orders on NASDAQ The flash order functionality makes it possible that, if an order has executed against the orders in the top of the NASDAQ order book, the remainder of the order is shown at the top of the book for a maximum of 500 ms instead of being sent to another... week over time (a), average number of messages per month of the year (b), average number of messages per day of the month (c), and the average number of messages per day of the week (d) over the period January 6, 2009eDecember 12, 2011 average Monday has about 20% less messages than the other days of the week, which is consistent with the lower trading volumes (and higher) volatility on Monday observed... another High- Frequency Activity on NASDAQ exchange If, after 500 ms, there is still reason to send the order to another exchange, the order is canceled (this is the case when the order is still marketable at another exchange) When there is no reason to send the order to another exchange (the order is nonmarketable at other exchanges), it remains in the order book until canceled by the customer The three... messages per day across all days in a certain month instead of averaging the messages per month and then averaging the months over the years Hence, we account for differences in the average number of trading days in different months and for the fact that our sample only contains the first half of December 2011 9 The Handbook of High Frequency Trading (b) average # messages per week over time 14 12 10... others From 1998 to 2008, he was Editor of Economic Papers, the policy journal of the Economic Society of Australia and was a member of the Central Council of the Economic Society of Australia In 2008, he received the Honorary Fellow Award of the Economic Society of Australia He is currently Associate Editor of Energy Economics and a member of seven editorial boards There are 4600 citations to his research... economics (2014) from the Erasmus University Rotterdam His research focuses on high- frequency and algorithmic trading, in particular the performance of high- frequency technical trading strategies, the behavior of algorithmic traders around macroeconomic announcements, and their role in initial trading for newly listed stocks Part of his work has been published in the Journal of Banking and Finance... trade of nondisplayable order message The Handbook of High Frequency Trading Panel A: full sample 2009–2011 High- Frequency Activity on NASDAQ (a) (b) (c) (d) Figure 1.1 Number of messages per pay Distribution of the number of messages per day over the period January 6, 2009 to December 12, 2011 in subplot (a) and separately for the Years 2009, 2010, and 2011 in Subplots (b) to (d) Figure 1.2 displays the. .. to the order book, it is referred to by means of the order identification number The only way to determine whether a nonadd order message is relevant to the order book of the S&P 500 ETF is by checking whether the order number is already in the order book The construction of the order book itself is a straightforward bookkeeping exercise that can be verified because the book, which starts empty at the. .. Third, the authors show that firm size, trading volume, and a stock’s listing exchange influence the price discovery of trades between nonhigh -frequency traders Chapter 16 observes that on April 2014, Michael Lewis released the high profile book Flash Boys on how investment brokerages colluded with stock exchanges and highfrequency traders to the detriment of other investors and the stability of the market . methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility. To the fullest extent of the law, neither the Publisher. was Editor of Economic Papers, the policy journal of the Economic Society of Australia and was a member of the Central Council of the Economic Society of Australia. In 2008, he received the Honorary Fellow. Alpha, and High Frequency Trading Review. He is the creator of the Cadogan stock price formula for high- frequency trading, and criterion function for predicting market crash from the probability weighting