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New Insights on Computerized Trading: Implications of Frequently Revised Trading Decisions
Stockholm University, Faculty of Social Sciences, Stockholm Business School.
2019 (English)Doctoral thesis, comprehensive summary (Other academic)
Abstract [en]

Computerized trading may be viewed as an aspect of modernization of financial markets. This dissertation contains four articles that in different ways examine to what extent the modernization influences the economics of the markets.

Article 1 investigates transaction costs for large orders which are split up by execution algorithms to be executed in smaller pieces.  I find that the costs associated with not being able to execute all pieces are substantial. These costs can be lowered by speeding up the trading pace but at the expense of higher costs for the successfully executed pieces.

Article 2 investigates the strategies trading firms pursue in particular cases, known as toxic arbitrage opportunities. We find that trading firms, that otherwise behave as market makers, morph into liquidity takers as toxic arbitrage opportunities emerge. In contrast to common belief, market makers are net beneficiaries of toxic arbitrage, and this finding puts into question whether the amount of toxic arbitrage leads to wider bid-ask spreads.

Article 3 investigates the information content of limit orders in an alternative way by studying the price impact implied by the depth in the limit order book. I find that the price impact estimates are slightly lower relative to those from a structural vector auto regressive model, but slightly higher compared to those from a price impact regression. Thus, the limit order book implied price impact estimates match those from benchmark models, and this finding contradicts earlier research.

Article 4 investigates the economic rationale behind limit order cancellations. We put forth a model that explains the frequent limit order cancellations seen in today’s markets, and we test its predictions using a unique data set from Nasdaq. Our results points towards that frequent order cancellations is a benign feature of modern market making, as opposed to different types of manipulative behavior.

Place, publisher, year, edition, pages
Stockholm: Stockholm Business School, Stockholm University , 2019. , p. 18
National Category
Business Administration
Research subject
Business Administration
Identifiers
URN: urn:nbn:se:su:diva-173359ISBN: 978-91-7797-869-5 (print)ISBN: 978-91-7797-870-1 (electronic)OAI: oai:DiVA.org:su-173359DiVA, id: diva2:1353285
Public defence
2019-11-06, Gröjersalen, hus 3, Kräftriket, Roslagsvägen 101, Stockholm, 14:00 (English)
Opponent
Supervisors
Note

At the time of the doctoral defense, the following papers were unpublished and had a status as follows: Paper 1: Manuscript. Paper 2: Manuscript. Paper 3: Manuscript. Paper 4: Manuscript.

Available from: 2019-10-14 Created: 2019-09-22 Last updated: 2019-10-18Bibliographically approved
List of papers
1. Transaction Costs of Large Orders, Trading Pace, and the Cost of Non-Execution
Open this publication in new window or tab >>Transaction Costs of Large Orders, Trading Pace, and the Cost of Non-Execution
(English)Manuscript (preprint) (Other academic)
Abstract [en]

Large orders are usually split into small pieces and traded over long time horizons. The order splitting reduces the price impact but increases the risk of non-execution. I show that the cost of non-execution can be substantial. By ignoring this cost, the literature underestimates the total transaction cost of large orders. Additionally, this article shows that investors can lower the cost of non-execution by speeding up the trading pace, which, however, increases the cost of successfully filled orders.  Investors’ choice of trading pace is associated with a trade-off where lowering one cost increases the other.

Keywords
Market microstructure
National Category
Business Administration
Research subject
Business Administration
Identifiers
urn:nbn:se:su:diva-173903 (URN)
Available from: 2019-10-01 Created: 2019-10-01 Last updated: 2019-10-02Bibliographically approved
2. Dr. Jekyll and Mr. Hyde: Market Makers and Toxic Arbitrageurs
Open this publication in new window or tab >>Dr. Jekyll and Mr. Hyde: Market Makers and Toxic Arbitrageurs
(English)Manuscript (preprint) (Other academic)
Abstract [en]

Toxic arbitrage opportunities can arise when the prices of two related securities move sequentially rather than simultaneously. Relatively slow liquidity providers could then incur losses to the arbitrageurs, known as snipers. We investigate arbitrage activity between futures and exchange-traded funds in the Swedish blue-chip index. We find that trading firms that otherwise behave as market makers morph into snipers as toxic arbitrage opportunities emerge. In contrast to common belief, market makers are net beneficiaries of toxic arbitrage. The finding can be rationalized by economies of scope, since both arbitrage and market-making strategies rely on low-latency market monitoring technology.

Keywords
Market microstructure
National Category
Business Administration
Research subject
Business Administration
Identifiers
urn:nbn:se:su:diva-173921 (URN)
Available from: 2019-10-01 Created: 2019-10-01 Last updated: 2019-10-02Bibliographically approved
3. What Does the Order Book Depth Tell Us about Price Impact?
Open this publication in new window or tab >>What Does the Order Book Depth Tell Us about Price Impact?
(English)Manuscript (preprint) (Other academic)
Abstract [en]

I estimate the price impact implied by limit order book (LOB) depth, using methodology from Sandås (2001). The idea is that LOB depth reflects market makers’ beliefs about the price impact of market orders. I find the price impact estimates are slightly lower than those from a structural vector autoregressive model, but slightly higher than those from price impact regression. Thus, the LOB-implied price impact estimates match those from benchmark models, contradicting earlier research. I shed new light on limit order informativeness, contributing to contemporary literature on the increased information content of limit orders relative to market orders.

Keywords
Market microstructure
National Category
Business Administration
Research subject
Business Administration
Identifiers
urn:nbn:se:su:diva-173914 (URN)
Available from: 2019-10-01 Created: 2019-10-01 Last updated: 2019-10-02Bibliographically approved
4. Determinants of Limit Order Cancellations
Open this publication in new window or tab >>Determinants of Limit Order Cancellations
(English)Manuscript (preprint) (Other academic)
Abstract [en]

We investigate the economic rationale behind limit order cancellations from the perspective of liquidity suppliers. We predict that an order is cancelled whenever its expected revenue no longer exceeds the expected cost and we model how order profitability variation can be determined from changes in the state of the order book and the order queue position. Our empirical evidence supports the predictions in general and for orders submitted by high-frequency trading firms in particular. Consistent with our model approach, we find that order cancellation patterns are more consistent with market making than with liquidity demand strategies.

Keywords
Market microstructure
National Category
Business Administration
Research subject
Business Administration
Identifiers
urn:nbn:se:su:diva-173916 (URN)
Available from: 2019-10-01 Created: 2019-10-01 Last updated: 2019-10-02Bibliographically approved

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New Insights on Computerized Trading(1769 kB)48 downloads
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