Posts Tagged ‘David Lesmond’

The high cost of high-frequency trading

Monday, December 10th, 2012

On May 6, 2010, the Dow Jones Industrial Average plunged nearly 600 points in five frantic minutes only to regain most of that loss minutes later. The origin of the so-called Flash Crash remains a mystery to this day, but David Lesmond, associate professor of finance at the A. B. Freeman School of Business, has a strong suspicion of the underlying cause: high-frequency trading.

“These high-frequency traders are hitting the market with such rapidity that the markets have to react to them,” says Lesmond, who has been studying the phenomenon for the past three years. “Then other algorithms take over and they sell as well, so you see a contagion effect.”

Associate Professor of Finance David Lesmond says high-frequency trading is largely to blame for increased volatility in the stock market.

High-frequency traders utilize powerful computers and complex algorithms to take advantage of slight price imbalances in the market. HFT firms typically place thousands of orders too small to appear in the consolidated feed of stock transactions, enabling the traders to fly under the radar of Wall Street and quietly gather information about the market. The vast majority of those orders — up to 98 percent — are never executed. Instead, they’re placed solely to probe the market and then cancelled within the blink of an eye. If a market maker tries to fill an order, the high-frequency trader might conclude that a large buyer is present and quickly purchase shares to sell back to the buyer at a slightly higher price. Speed is everything.

“It’s gotten to the point that the high-frequency traders worry about the length of cord that connects the computers,” Lesmond says. “You’re thinking milliseconds at this point.”

While supporters argue that high-frequency traders reduce transaction costs and provide liquidity to the market, Lesmond has a different perspective.

“It’s price manipulation,” Lesmond says. “That’s the principal worry that everybody has about these high-frequency traders. Because if the price doesn’t reflect information, you have no transparency in the market, and if you don’t have transparency in the market, who gets the short end of the stick? The investors.”

According to some estimates, high-frequency trading comprises about 70 percent of all equities trading volume, but Lesmond says it’s difficult to quantify the volume because those trades don’t appear on the consolidated feed of stock transactions. As part of his current research, Lesmond hopes to generate a more accurate estimate of HFT volume and also get a clearer picture of its effects on the market, including whether or not the prices high-frequency traders buy and sell at reflect information.

“My feeling is that the prices do not reflect information in the market, and that’s just catastrophic,” Lesmond says. “If prices can be dictated by these off-exchange things, then we have no hope. That’s by definition what market manipulation is.”

Steps may already be underway to address the problem. Reuters recently reported that U.S. equities markets and regulators have agreed to add trades of less than 100 shares, referred to as odd lot trades, to a feed of real-time market data in an effort to boost transparency.

But according to Lesmond, the real source of the problem remains the low cost of trading. In the wake of the stock market’s conversion to decimalization in 2001, bid/ask spreads dropped to a penny or less,  essentially eliminating cost barriers to trading. High-frequency trading, Lesmond says, was an unintended consequence of the conversion.

Regulators are now considering a tax to be placed on each order to force high-frequency traders to incur some cost for their activities, a reform that Lesmond says could greatly reduce their negative impacts on the market.

“I think regulators mostly want to inhibit high-frequency traders from submitting false trades—the trades that are submitted and then immediately retracted,” says Lesmond. “By instituting a tax on trades, however small, they hope to lessen the frequency of trade and that in turn may help stabilize the market, not to mention government coffers.”



New lab gives students the power of Bloomberg Professional

Wednesday, October 24th, 2012

Bloomberg is the world’s leading provider of news, data and analytics for finance professionals. Now, thanks to a new agreement, the Freeman School is making the company’s flagship desktop product — the Bloomberg Professional service — fully available to students.

Bloomberg Lab

In August, the Freeman School unveiled a new lab dedicated exclusively to the Bloomberg Professional service, the world’s leading financial news, data and analytics platform.

This summer, the Freeman School acquired 12 new subscriptions to the service, enabling the creation of a new computer lab dedicated exclusively to Bloomberg. The lab, located on the first floor of Goldring/Woldenberg Hall I, provides students with 24-hour access to real-time and historical data on commodities, derivatives, equities, fixed income and foreign exchange securities.

“Bloomberg offers users a staggering array of financial tools and information,” says Ira Solomon, dean of the Freeman School, who worked closely with faculty, staff and representatives from Bloomberg to make the lab a reality. “By making those tools and information available to students, we hope to enhance their understanding of key concepts and reinforce the theories they’re learning in the classroom.”

While the Freeman School’s Turchin Library has offered students limited access to the Bloomberg Professional service for a number of years, the new lab allows faculty members to fully leverage the power of Bloomberg in the classroom, enabling projects that let students apply conceptual knowledge to real-world examples.

Sheri Tice, for example, who teaches the Freeman School’s Darwin Fenner Fund course, is having her students use Bloomberg to run a host of sophisticated analyses on the fund, a $2.6 million stock portfolio managed entirely by the students.

“There are a bunch of portfolio analysis tools that are only available on Bloomberg,” says Tice, the A. B. Freeman Endowed Chair in Finance. “I can ask the students to determine if portfolio outperformance comes from taking on risk or represents abnormal performance, or I can ask them if outperformance comes from superior company-selection ability or industry-selection ability. The tools they need to answer those questions are only available on Bloomberg.”

David Lesmond, associate professor of finance, is having his Master of Finance students conduct a financial analysis of a firm, including forecasting what the company’s earnings are likely to be at the end of the semester.

“They’re using Bloomberg for almost everything,” says Lesmond. “As opposed to simply doing a problem at the back of a textbook, they’re using actual data to determine characteristics that we’d otherwise just talk about. It makes the lessons learned a lot more real.”

With the opening of the new lab, Freeman students now have access to the two leading financial data products on the market: the Bloomberg Professional service and Thomson Reuters Eikon, which is installed on work stations in the Freeman School’s Trading Center. According to Lesmond, that gives students a tremendous advantage.

“Every desk that does financial analysis is either going to have a Reuters terminal or a Bloomberg application,” Lesmond says. “By giving our students that experience while they’re still in school, they’re going to be able to step into those environments seamlessly and start contributing from day one.”



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