Asset Management/ Market Design

CFP Asset Management and Market Design Track Lead Albert “Pete” Kyle spoke at the Flash Crash Conference: One Year Later, conducted several interviews after the conference 
Financial Times: Critics question real-time reporting proposal SEC still lacks tools to prevent ‘flash crashes’ Flash crash questions linger a year after plunge

Statements and Commentary

Buying and selling at the speed of light: Taking stock of high frequency trading
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On June 18, 2012 research track lead Pete Kyle spoke at the American Enterprise Institute (AEI) about high frequency trading (HFT), its implications for the financial industry, and some possible reforms.

Discussion of Cost-Benefit Analysis in SEC Rulemaking
by Albert S. (Pete) Kyle
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On April 16, 2012 at Columbia University’s Law and Economics of Capital Markets Fellows Workshop, Professor Kyle discussed the cost-benefit analysis of SEC rulemaking. As a framework for his presentation, Professor Kyle examined the six recommendations of the SEC’s Office of Inspector General study on the topic and offered his opinion of each recommendation.

Financial Economists Roundtable (FER) Statement of the Financial Economists Roundtable on Reforming the OTC Derivatives Markets
by Chester S. Spatt, Darrell Duffie and Albert S. (Pete) Kyle
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Research Track Lead Pete Kyle and CFP Academic Fellow Chester Spatt authored this FER statement released on June 29, 2010, a result of a discussion at FER's annual meeting on July 18-20, 2009 at Skamania Lodge in the Columbia River Gorge. Professors Kyle and Spatt, along with CFP Director Lemma Senbet, are members of The Financial Economists Roundtable, a group of senior financial economists, who have made significant contributions to the finance literature and seek to apply their knowledge to current policy debates.  

Working Papers

Monitoring Daily Hedge Fund Performance When Only Monthly Data is Available
By Russ Wermers, Daniel Li, Michael Markov
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Abstract: This paper introduces a new approach to monitoring the daily risk of investing in hedge funds. Specifically, we use low-frequency (monthly) models to forecast high-frequency (daily) hedge fund returns.

This approach addresses the common problem that confronts investors who wish to monitor their hedge funds on a daily basis—disclosure of returns by funds occurs only at a monthly frequency, usually with a time lag. We use monthly returns on investable assets or factors to fit monthly hedge fund returns, then forecast daily returns of hedge funds during the following month using the publicly observed daily returns on the explanatory assets. We show that our replication approach can be used to forecast daily returns of long/short hedge funds. In addition, for diversified portfolios such as hedge fund indices and funds-of-hedge-funds, it forecasts daily returns very accurately. We illustrate how our simple replication approach can be used to (1) hedge daily hedge fund risk and (2) estimate and control value-at-risk.

A Call for Credit Policy
by Dilip B. Madan
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Abstract: Madan's submission for the ICFR-FT Research Prize for 2010 was among the top ten submissions. The paper summarizes recent research explaining why capital requirements are needed, who should be faced with such, and how they should be determined and implemented.

The paper calls for a credit and leverage monitoring authority but more importantly develops the theoretical foundations for such an activity. These foundations build on the theory of two price markets recognizing that liabilities on balance sheets are to be valued at ask prices while assets are carried at bid. Capital reserves making up for the difference. Inadequacies in Basel capital ratio definitions are highlighted.

The Flash Crash: The Impact of High Frequency Trading on an Electronic Market
by Andrei Kirilenko, Mehrdad Samadi, Albert S. Kyle, Tugkan Tuzun
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Abstract: The Flash Crash, a brief period of extreme market volatility on May 6, 2010, raised a number of questions about the structure of the U.S. financial markets. In this paper, we describe the market structure of the bellwether E-mini S&P 500 stock index futures market on the day of the Flash Crash.

We use audit-trail, transaction-level data for all regular transactions to classify over 15,000 trading accounts that traded on May 6 into six categories: High Frequency Traders, Intermediaries, Fundamental Buyers, Fundamental Sellers, Opportunistic Traders, and Noise Traders. We ask three questions. How did High Frequency Traders and other categories trade on May 6? What may have triggered the Flash Crash? What role did High Frequency Traders play in the Flash Crash? We conclude that High Frequency Traders did not trigger the Flash Crash, but their responses to the unusually large selling pressure on that day exacerbated market volatility.

Mutual Fund Performance and Governance Structure: 
The Role of Portfolio Managers and Boards of Directors
by Bill Ding & Russ Wermers
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Abstract: This paper conducts a comprehensive analysis of the relation between the performance and governance structure of open-end, domestic-equity mutual funds during the 1985 to 2002 period.

We show that experienced large-fund portfolio managers outperform their size, book-to-market, and momentum benchmarks, but that experienced small-fund portfolio managers underperform their benchmarks—indicating the presence of managerial entrenchment in the mutual fund industry. When we examine the role of fund boards, we find that independent directors are crucial for terminating underperforming seasoned portfolio managers, as outflows are not sufficient to pressure the management company to do so. In fact, our evidence indicates that independent boards impact pre-expense performance much more significantly than their prior-documented impact on fund fees. We also find a role for internal governance: inside directors and large management company complexes appear to better monitor performance due to “hidden actions,” as well as terminating underperforming inexperienced managers.