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Market Design & Microstructure


CFP faculty advisor and special fellow Albert “Pete” Kyle spoke at the Flash Crash Conference: One Year Later, conducted several interviews after the conference.

Buying and selling at the speed of light: Taking stock of high frequency trading

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. Watch the video.


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.

How Your Counterparty Matters: Using Transaction Networks to Explain Returns in CCP Marketplaces
By CFP Faculty Associate Ethan Cohen-Cole, Andrei A. Kirilenko, and Eleonora Patacchini
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Abstract: We study the profitability of traders in two fully electronic, highly liquid markets, the Dow and S&P 500 e-mini futures markets.

We document and seek to explain the fact that traders that transact with each other in this market have highly correlated returns. While traditional least squares regressions explain less than 1% of the variation in trader-level returns, using the network pattern of trades, our regressions explain more than 70% of the variation in returns. Our approach includes a simple representation of how much a shock is amplified by the network and how widely it is transmitted. It provides a possible shorthand for understanding the consequences of a fat-finger trade, a withdrawing of liquidity, or other market shock. In the S&P 500 and DOW futures markets, we find that shocks can be amplified more than 50 times their original size and spread far across the network. We interpret the link between network patterns and returns as reflecting differences in trading strategies. In the absence of direct knowledge of traders’ particular strategies, the network pattern of trades captures the relationships between behavior in the market and returns. We exploit these methods to conduct a policy experiment on the impact of trading limits.

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.